HF 


THE  LIBRARY 

OF 

THE  UNIVERSITY 
OF  CALIFORNIA 


HENRY  RAND  HATFIELD 
MEMORIAL  COLLECTION 

PRESENTED  BY 

FRIENDS  IN  THE  ACCOUNTING 
PROFESSION 


AN  INTRODUCTION 

TO 

ELEMENTARY  ACCOUNTING 


BY 


A.  C.  LITTLETON,  A.  M.,  C.  P.  A., 

ASSOCIATE  IN  ACCOUNTANCY 
UNIVERSITY  OF  ILLINOIS 


SOUTH-WESTERN  PUBLISHING  Co. 

CINCINNATI,  OHIO 

1920 


PROGRAM  OF  ASSIGNMENTS 

FOR  COMPLETING 
LITTLETON'S  INTRODUCTION  TO  ELEMENTARY  ACCOUNTING 

CORRELATING  IT  WITH 

20TH  CENTURY  BOOKKEEPING  AND  ACCOUNTING. 

This   program    is   followed    in '  the    elementary    accounting    classes    in    the 
State  University  of  Illinois. 

Accountancy  la 


QUIZ    ASSIGNMENTS 

1 — Introduction  to  Elementary  Ac- 
counting. Chap.  I  —  The  Pur- 
pose of  Acounting. 

2 — Introduction  —  Chap.  II  —  The 
Transaction. 

3 — Review  first  two  chapters;  dis- 
cuss the  problems  worked  in 
practice  class. 


4— Introduction,  Chap.  Ill  —  The 
Ledger. 

5 — Oral  analysis  and  recitations  on 
problems  from  Chap.  Ill  and 
others  to  be  stated  by  the  in- 
structor. 

6— Introduction,     Chap.     IV— Trial 

Balance  and  Statements. 
7 — (a)       Introduction,    Chap.    V — 
Personal  accounts  and  the  Jour- 
nal. 

(b)      20th  Century  text  pp.   30- 
33. 

8— (a)  Introduction,  Chap.  VI— 
Special  Books  of  Original  En- 
try. 

(b)       20th  Cent,   text,  pp.   34-42. 
9 — Study  Jan.  transactions  in  ad- 
vance   at    home    and    recite    on 
them  in  quiz  class. 

10— (a)     Introduction,    Chap.   VII— 
Direct  Ledger  Closing, 
(b)     Compare    with    explanation 
and   illustration   in   appendix   of 
20th  Oentury  text. 

11 — Introduction,  problems  from 
Chap.  VII. 

12 — One-hour  written  quiz. 

13 — Study  Feb.  transactions  in  ad- 
vance at  home  and  recite  there- 
on in  class. 

14— (a)  Introduction,  Chap.  VIII— 
Journal  Closing. 

(b)     Compare  with  explanations 
and    illustrations    pp.    67-70    of 
20th  Cent.  text. 
(Concluded   on  next  page) 


PRACTICE    ASSIGNMENTS 
1 — Problems  from  Chap.  I. 


2 — Problems  1  and  2  from  Chap. 
II. 

3 — (a)  Problem  3,  from  Ohap.  II. 
(b)  Follow  instruction  for  prob- 
lem 2,  Chap.  II,  using  the  data 
in  Exercise  24,  p.  44  of  20th 
Century  text. 

4 — Problems  from  Chap.  III. 

5 — Follow  instructions  in  problem 
1,  of  Chap.  Ill,  but  use  the 
transactions  in  the  following 
Ex.  in  20th  Century  text— Ex. 
3-5-9-11-15-18. 

6— Problems  from  Chap.  IV. 

7— (a)     Problems  from  Chap.  V. 
(b)     Journal    Entries    for   Exer- 
cise 25,  p.  45  of  20th  Cent.  text. 


8 — Begin  Set  I;   go  as  far  as  Jan. 
12. 


9 — Continue  Set  I  to  Jan.  24. 


10 — (a)     Finish     Jan.    transactions 
and  post, 
(b)     Jan.  Trial  Balance. 


11 — Jan.  Statements  and  closing  of 
Set  I. 

12 — Two-hour  problem  quiz. 

13— Set  I  to  Feb.  24.  The  instruc- 
tor will  advise  as  to  abbrevi- 
ating the  clerical  work  in  the 
sales  Book. 

14 — Finish  Feb.  entries,  posting  and 
Trial  Balance. 
(Concluded   on  next  page) 


AN  INTRODUCTION 

TO 
ELEMENTARY  ACCOUNTING 


BY 


A.  C:  LITTLETON,  A.  M.,  C.  P.  A. 

ASSOCIATE  IN  ACCOUNTANCY 
UNIVERSITY   OF   ILLINOIS 


PUBLISHED  BY 

SOUTH-WESTERN  PUBLISHING  Co., 

CINCINNATI,  OHIO, 

1920 


COPYRIGHT  1919 

BY 
A.  C.  LITTLETON 


i 

PURPOSE  OF  ACCOUNTING 

We  may  study  accounting  intending  to  follow  it  as  a  profession 
or  to  use  it  as  a  stepping  stone  to  other  things  in  business,  or  we 
may  study  it  in  order  as  superintendents,  managers,  proprietors,  to 
use  intelligently  the  accounting  results  which  others  will  furnish  us. 
But  whether  we  expect  to  "keep  books"  or  to  have  them  kept  for  us, 
it  is  highly  necessary  to  understand  thoroughly  the  language  and 
methods  of  accounting. 

Financial  Condition.  Accounting  has  for  its  principal  aim  the 
presentation  of  the  vital  facts  concerning  the  financial  condition  and 
progress  of  a  business.  One  of  the  most  important  documents  con- 
taining vital  business  facts  that  is  placed  before  the  business  execu- 
tive or  proprietor  is  the  statement  of  his  financial  condition,  called 
the  Balance  Sheet.  Herein  is  a  tabulation  of  all  he  possesses  in  the 
way  of  business  property  and  of  any  claims  there  may  be  against 
that  property. 

If  the  proprietor  owns  all  the  property  he  holds,  the  statement  is 
as  follows: 

BALANCE  SHEET— H.  R.  WELLS 

Property  Possessed  Claims  Against  Property 

Cash    $  7,000 

Land  &  Bldg 9,000 

Furniture    800 

Delivery    Car 1,500  H.  R.  Wells,  Propr $18,300 


$18,300  $18,300 

If,  however,  Mr.  Wells  holds  an  automobile  delivery  car  worth 
$1,500,  but  has  paid  only  $1,000  on  it,  some  one  else  (the  seller)  has 
a  legal  claim  against  the  car  until  the  $500  is  paid  as  well.  Indeed, 
the  seller  would  have  a  claim  against  any  or  all  of  the  property  up 
to  the  amount  of  the  unpaid  debt.  In  order  to  present  the  true  con- 


dition  under  these  circumstances,  the  statement  will  have  to  be  as 
follows : 

BALANCE  SHEET— H.  R.  WELLS 

Property  Claims 

Cash    $  7,000  Blank  Auto  Co $      500' 

Land   &   Bldg 9,000 

Furniture 800 

Delivery    Car 1,500  H.  R.  Wells,  Propr 


$18,300 

The  above  statement  clearly  shows  that  the  proprietor  claims 
whatever  portion  of  the  property  is  not  claimed  by  outsiders.  In  fact, 
one  of  the  great  services  of  this  statement  of  financial  condition  is  to 
show  the  value  of  the  proprietor's  interest  in  the  property.  This  value 
(often  called  Present  Worth  or  Net  Worth)  is  the  difference  be- 
tween the  total  property  and  the  total  of  claims  by  persons  outside 
the  business.  It  is  to  be  noted  as  a  result  of  this  principle  that  the 
total  of  the  claims  column  in  the  Balance  Sheet  will  always  be  equal 
to  the  total  of  the  property  column. 

Business  on  Credit.  We  have  seen  that  the  unpaid  portion  of 
the  automobile's  purchase  price  constitutes  a  debt  to  be  paid  later,  and 
gives  the  seller,  who  trusted  Mr.  Wells,  a  claim  against  the  latter's 
property  until  the  obligation  is  discharged  by  payment.  We  must 
see,  also,  that  Mr.  Wells  may  sell  as  \vell  as  buy  on  credit  (i.  e.,  on 
trust).  Assuming  that  he  has  done  so,  and  that  certain-  persons  owe 
him  $2,200  for  goods  sold  them,  then  the  Balance  Sheet  would  be  as 
follows : 

BALANCE  SHEET— H.  R.  WELLS 

Property  Claims 

Cash    $  7,000  Debts  Payable. $     500 

Debts  Receivable 2,200 

Land  &  Bldg 9,000 

Furniture 800 

Delivery    Car 1,500  H.  R.  Wells,  Propr 20,000 


$20,500  $20.500 

Two  points  are  to  be  noticed  in  this  last  statement.  Under  the 
new  conditions,  there  was  total  property  of  $20,500,  and  there  were 
claims  by  outsiders  of  $500,  leaving  $20,000  as  the  Present  Worth 
of  the  business.  Then  there  is  introduced  the  terms  Debts  Receivable 


and  Debts  Payable.*  They  are  easily  explained.  If  we  sell  on  credit, 
the  transaction  gives  rise  to  a  debt  which  is  receivable  by  us  in  cash 
at  some  later  date;  if  we  buy  on  credit,  the  transaction  gives  rise  to  a 
debt  payable  by  us  at  some  later  date. 

The  fact  that  Mr.  Wells  owes  for  part  of  his  delivery  car  leads 
to  the  suggestion  that  the  statement  would  be  more  interesting  to  the 
proprietor  if  the  names  of  the  people  owed  were  shown.  It  is  impor- 
tant that  he  know  to  whom  he  owes  money,  as  well  as  to  know  the 
total  amount;  it  is  equally  important  to  know  from  whom  to  expect 
payments,  as  well  as  to  know  the  total  owed  to  him.  Another  revision 
will  therefore  be  made  in  the  Balance  Sheet : 

BALANCE  SHEET— H.  R.  WELLS 

Property  Claims 

Cash    $  7,000  Debts  Payable : 

Debts  Receivable :  Blank  Auto  Co $      500 

M.  Y.  Jones $1,700 

P.J.Frank 500        2,200 

Land  &  Bldgs 9,000 

Furniture  800 

Delivery  Car 1,500  H.  R.  Wells,  Propr 20,000 


$20,500  $20,500 

Use  of  the  Balance  Sheet.  With  this  statement  before  him,  the 
Proprietor  can  view  his  business  in  perspective,  so  to  speak. 
He  can  see  how  his  property  is  divided  between  Cash,  Debts,  Land, 
Furniture,  etc.;  how  outsiders  have  claims  against  a  part  of  his  prop- 
erty; how  much  property  is  free  from  outside  claims,  and  therefore 
is  his  own.  Because  this  statement  shows  the  business  man  just  how 
he  stands  financially,  it  is  regarded  as  a  very  important  document. 
Without  knowing  periodically  just  how  he  stands,  the  business  man 
runs  grave  risks  in  undertaking  large  purchases  or  in  incurring  large 
debts.  Should  he  buy  beyond  his  ability  to  pay  he  would  soon  fail 
in  business.  He  would  be  wise  to  look  over  his  statement  before  buy- 
ing heavily,  and  consider  the  debts  he  already  has,  and  the  extent  of 
the  property  at  hand  that  could  be  used  in  paying  them  or  any  new 
ones. 

Profit  and  Loss.  There  is  another  statement  the  business  man 
likes  to  have  presented  periodically;  one  that  permits  him  to  see  the 
Profits  or  the  Losses  the  business  has  experienced. 


*The  terms  here   used   will  be  replaced   at  the  proper   time  by   a   more 
technical  phraseology. 


Profit  comes  to  the  merchant  in  buying  at  one  price  and  selling 
at  a  higher.  The  man  who  deals  in  large  ventures,  like  buying  and 
selling  residence  and  business  real  estate,  may  calculate  his  profits 
on  each  transaction.  His  statement  of  profits  and  losses  might  be  as 
follows : 

Sold  5th  Street  Property  for $10,000 

Fifth  Street  Property  cost 7,000 


Profit   $3,000 

Sold  7th  Street  Property  for ..  8,000 

Seventh  Street  Property  cost 6,000 


Profit  2,000 


Total   Profits $5,000 

But  the  retail  merchant  selling  clothing,  groceries,  or  hardware 
can  not  follow  the  real  estate  man's  example.  The  retailer  buys  many 
small  and  different  articles,  and  sells  them,  generally,  one  by  one. 
He  can  not  hope  to  keep  records  so  that  he  could  calculate  the  profit 
on  each  separate  article  sold.  So  his  Profit  and  Loss  Statement  must 
consist  of  totals  instead  of  details.  If,  in  a  given  period,  he  sells 
goods  to  the  total  value  (at  selling  price)  of,  say,  $7,000,  and  finds 
that  these  goods  cost  $4,000  when  purchased,  there  is  a  difference  of 
$3,000,  which  is  profit.  In  statement  form  the  facts  would  be  arranged 
thus  : 

STATEMENT  OF  PROFIT  AND  LOSS 

Total  Sales $7,000 

Total  Cost  of  Purchases* 4,000 


Difference,    Profit $3,000 

Stated  in  another  way,  Profit  is  the  portion  of  the  sales  price 
remaining  after  the  purchase  cost  has  been  recovered.  When  some 
one  buys  of  us  $7,000  worth  of  merchandise,  he  is  repaying  us  what 
we  paid  for  the  articles  and  something  more — a  profit  for  the  service 
we  render  him  in  supplying  the  goods. 

Expense.  If  the  proprietor  employs  a  clerk  to  wait  upon  cus- 
tomers, the  selling  price  of  goods  must  be  sufficient  to  repay  the  pro- 
prietor not  only  the  cost  of  the  goods  themselves,  but  the  clerk's 


*The  assumption  is  here  made  that  all  of  the  goods  bought  have  been 
sold;  later  the  case  will  be  considered  in  which  all  of  the  purchases  are  not 
sold. 


wages  also,  before  there  can  be  any  profit.  Rent  of  store  would  be 
like  wages  in  this  respect.  The  proprietor  pays  Rent  and  Wages, 
perhaps,  before  any  sale  is  made.  He  must  get  back  from  the  cus- 
tomers enough  to  reimburse  him  for  these  payments  before  the  busi- 
ness can  be  said  to  yield  him  any  profit. 

When  a  business  man  buys  goods  to  sell,  and  pays  wages,  rent, 
etc.,  he  pays  out  money  which  he  expects  later  to  recover  through 
selling  goods  to  customers.  In  making  these  payments  he  is  not  buy- 
ing permanent  things  like  buildings  or  land,  which  last  many  years. 
He  is,  in  a  way,  only  putting  his  money  into  goods,  rent,  etc.,  tempo- 
rarily ;  he  soon  gets  it  back.  Such  payments  may  be  called  by  the  dis- 
tinctive title  of  "Recoverable  Outlays",  i.  e.,  money  "laid  out"  or  paid 
out  to  be  recovered  later. 

We  have  to  note  two  classes  of  Recoverable  Outlays,  namely, 
Purchases  and  Expenses.  By  Purchases  we  understand,  "purchases 
of  merchandise  to  be  resold."  If  a  delivery  car  were  bought,  it  could 
not  properly  be  classed  as  "Purchases".  Although  it  was  purchased 
(bought),  it  is  for  use  and  not  for  sale.  To  a  dealer  in  automobiles, 
however,  it  might  well  enough  be  classed  as  "Purchases",  for  in  that 
case  it  would  be  an  article  in  his  stock  in  trade,  bought  for  the  ex- 
press purpose  of  resale. 

By  Expenses  we  understand  payments  made  for  services  (as  of 
clerks,  buildings,  light  plants,  lawyers,  telephones),  and  for  articles 
consumed  in  operating  the  business  (as  paper,  coal,  gasoline). 

The  cost  of  both  classes  of  outlay  must  be  recovered  before  there 
can  be  any  profit  for  the  proprietor,  and  the  only  source  from  which 
the  costs  can  be  recovered  is  sales.  So,  in  arranging  the  facts  to  form 
a  Statement  of  Profit  and  Loss,  one  begins  with  the  Sales  and  de- 
ducts, first,  the  Purchases,  to  show  that  outlay  recovered,  and  then, 
from  the  remainder,  deducts  the  Expenses,  to  show  those  outlays  also 
recovered.  When  all  Recoverable  Outlays  have  been  deducted,  there 
remains  the  proprietor's  profit.  Accordingly  the  Statement  takes  this 
form: 

STATEMENT  OF  PROFIT  AND  LOSS— H.  R.  WELLS 


Sales  $  7,000 


Purchases  4,000 


Gross   Profit 3,000 


Net  Profit 2,200 

Note  the  terms  used  in  the  above  statement.    Gross  Profit  means, 

7 


literally,  Great  Profit;  that  is  to  say,  the  profit  before  any  Expenses 
are  deducted;  it  is  the  first  profit,  the  bare  difference  between  the 
selling  prices  and  the  purchase  prices.  Net  Profit  is  the  last  or  final 
profit,  after  all  deductions  have  been  made.  It  is  the  amount  the 
Proprietor  may  feel  free  to  withdraw  from  the  business  if  he  wishes. 

Use  of  the  Statement.  With  this  statement  before  him  the  busi- 
ness man  can  see  zvhy  his  profit  is  as  it  is.  He  can  see  that,  if  he 
could  cut  down  on  Expenses,  his  Net  Profit  would  be  greater,  because 
there  would  be  less  to  deduct  from  the  Gross  Profit,  and  that  if  Ex- 
penses increased,  his  Net  Profit  would  be  correspondingly  less.  Like- 
wise, if  he  can  buy  goods  cheaper,  or  increase  his  selling  price,  he 
stands  to  gain  more;  but  if  sales  have  to  be  made  at  lower  prices  or 
purchases  at  higher,  he  stands  to  gain  less.  Again,  if  he  can  sell 
more  goods,  even  at  the  same  price,  he  can  increase  his  profit,  pro- 
vided he  can  keep  the  Expenses  from  going  up  in  the  same  proportion. 

Curiously  enough,  in  the  study  of  bookkeeping,  the  starting  point 
is  the  end.  It  is  pointed  out  above  that  the  aim  of  accounting  was 
to  present  the  vital  facts  concerning  the  financial  condition  of  a  busi- 
ness and  its  progress.  The  two  statements  discussed,  it  will  be  readily 
seen,  do  present  the  vital  facts  about  a  business.  So  here  in  the  very 
beginning  we  see  that  the  purpose  of  bookkeeping  is  to  furnish  these 
statements. 

The  question  naturally  following  an  understanding  of  what  the 
statements  are  is,  How  are'  they  obtained?  To  have  the  answer  is  to 
have  learned  bookkeeping,  for  bookkeeping  is  the  means  by  which  the 
daily  occurrences  in  a  business  are  tabulated  so  that  financial  state- 
ments can  be  readily  prepared  at  frequent  intervals.  The  work  now 
before  us  is  to  build  from  this  foundation  of  a  clear  understanding  of 
the  purpose  of  bookkeeping,  so  that  methods  and  systems  of  record- 
ing shall  be  clearly  related  to  a  definite  aim  and  to  each  other. 

PROBLEMS— CHAPTER  I. 

i.  Prepare  the  Balance  Sheet  for  the  Clayton  Hardware  Com- 
pany, owned  by  C.  H.  Clayton,  from  the  following  facts :  Mr.  Clay- 
ton places  all  the  information  about  his  affairs  at  your  disposal,  dis- 
claiming any  knowledge  of  accounting,  and  asking  only  that  he  be 


given  a  statement  showing  the  financial  condition  of  his  hardware 
business  on  July  i>  leaving  out  anything  not  related  to  the  business. 

Cash  at  the  store $      100 

Cash  in  bank 1,700 

Cash,  Mrs.  Clayton's  Saving  Account 300 

Delivery  Automobile 1,200 

Electric  Runabout 2,600 

Stock  of  Hardware 14,000 

Furniture,  etc.,  at  store . : 900 

Furniture,  etc.,  at  home 3,000 

Residence  11,500 

Owing  to  Hartford  Electric  Company  on  runabout 300 

2.  Show  the  Balance  Sheet  of  H.  R.  Wells  (page  3)  as  it  would 
stand  after  he  had  lost  his  $6,000  store  building  by  fire,  assuming  it 
was  uninsured.    All  of  the  furniture  was  lost  also. 

3.  John  Hancock,  after  selling  his  business  properties,  asks  you 
to  tell  him  what  his  standing  is.     Make  the  statement  to  show  him 
the  facts.     If  the  balance  is  not  Net  Worth,  give  it  a  name  which 
seems  to  you  to  describe  what  it  represents. 


Cash    ; $  2,500 

A.  K.  Smith  owes  John  Hancock 157 

J.  C.  Peters  owes  John  Hancock 202 

John  Hancock  owes  to  Parker   Brown 1,200 

John  Hancock  owes  to  Smith  &  Debs 850 

John  Hancock  owes  to  Willis  Supply  Co 150 

JoHn  Hancock  has  borrowed  from  the  First  National  Bank.  1,000 

4.  Compare  the  following  Balance  Sheet  with  the  one  for  H.  R. 
Wells  on  page  5.  Which  business  would  ^ou  rather  own,  and  why? 
Which  business  would  you  rather  sell  goods  to,  and  why? 


BALANCE  SHEET— K.  D.  COATES 

Property  Claims 

Cash    .....$      500  Debts    Payable..  ..$6,500 

Debts  Receivable 5,000 

Land    &    Buildings 13,000 

Furniture    500 

Delivery    Car 1,500  K.  D.  Coates,  Propr 14,000 

$20,500  $20,500 

5.     From  the  following  purchases,  sales,  etc.,  select  the  proper 
ones   for  the  construction  of  the  Profit  and  Loss   Statement  of  the 


II 

TRANSACTIONS 

The  financial  condition  of  a  going  business  is  constantly  under- 
going changes.  The  amount  of  cash  on  hand,  for  example,  is  seldom 
the  same  two  days  in  succession;  every  payment  and  every  receipt 
changes  it.  If  a  number  of  typical  business  occurrences  (often  called 
Transactions)  be  examined,  and  their  effect  upon  Property  and 
Claims  noted,  certain  peculiarities  of  accounting  will  become  evident. 

We  shall  assume  that  on  a  given  date  the  condition  of  Mr. 
Wells'  business  is  as  set  forth  in  the  Statements  below: 

BALANCE   SHEET— H.  R.   WELLS 

Property  Claims 

Cash    $  7,000  Debts  Payable  : 

Debts  Receivable  :  Blank  Auto  Co $      500 

M.  Y.  Jones $1,700 

P.  J.  Frank 500  2,200            H.  R.  Wells : 

Land  &  Bldgs 9,000                 Original  investment. $17,800 

Furniture    800                 Profit  shown  below .     2,200 

Delivery  Car 1,500  Present  worth 20,000 

$20,500  $20,500 

STATEMENT  OF  PROFIT  AND  LOSS— H.  R.  WELLS 

Sales    ; $  7,000 

Purchases   4,000 


Gross    Profk '. 3,000 

Expenses    800 

Net  Profit   (added  to  Investment) 2,200 

Investment  Transactions.  If  we  may  further  assume  certain 
typical  happenings  (Transactions),  the  changes  made  in  the  state- 
ments because  of  them  can  be  readily  studied. 

1 — Wells,  having  received  $5.000  by  the  will  of  an  uncle,  invests 
this  sum  in  the  business  he  has  been  operating. 

As  soon  as  this  money  has  been  put  in  the  cash  drawer  or  bank 
account  of  the  business,  the  property  available  for  business  purposes 

11 


business,  and  make  the  statement.    The  following  were  purchased  ( for 
cash  unless  otherwise  stated)  : 

Delivery  Car $  1,000 

Merchandise    1,200 

Sealskin  Coat 700 

Merchandise  on  credit 1,500 

Services  of  clerk 40 

Services  of  housemaid 30 

Repairs  to  delivery  car 150 

Use  of  store  building 200 

The  following  were  sold  (for  cash  unless  otherwise  stated)  : 

Merchandise    $  2,000 

Two  extra  auto  tires  at  cost 50 

Merchandise  on   credit 2,100 

The   children's    pony 500 

6.  Make  three  Profit  and  Loss  Statements,  using  your  own 
figures.  Choose  figures  to  show  that  the  net  profits  of  Business  A, 
as  compared  with  Business  B,  are  $2,000  smaller  because  of  bad  man- 
agement. How*  should  A  undertake  to  make  a  better  showing  in  the 
future  ?  Choose  figures  to  show  that  the  net  profits  of  Business  C 
was  $1,000  smaller  than  A  because  of  unwise  buying. 


10 


is  increased.  There  is  now  total  property  of  $25,500  (20,500  plus 
5,000),  since  the  Cash  is  made  $12,000.  But  let  it  be  also  noted  that 
this  is  not  the  only  effect  of  this  additional  investment.  Recall  the 
principle  that  whatever  property  the  business  has  which  is  not 
claimed  by  outsiders  will  be  claimed  by  the  proprietor.  No  outsider 
can  have  any  claim  against  the  $5,000,  so  it  follows  that  the  proprie- 
tor's interest  in  the  business  is  the  larger. 

To  show  this  state  of  affairs,  the  original  investment  of  $17,800 
is  changed  to  $22,800  to  include  the  new  $5,000.  Of  course  the  Pres- 
ent Worth  would  have  to  be  changed,  also  $5,000,  so  it  would  become 
$25,000.  . 

When  these  changes  have  been  made  in  the  statement,  it  should 
be  observed  that  the  total  Property  and  the  total  Claims  are  still 
equal,  although  larger  in  amount.  This  equality  of  totals  will  always 
be  true,  because,  in  expressing  the  changes  made  by  the  transactions, 
there  are  always  two  equal  changes  made. 

2 — Wells  found  one  morning  that  the  store  had  been  entered  and 
$100  stolen  from  the  cash  drawer. 

Clearly,  the  cash  on  hand  is  less,  and  the  statement  reflecting  the 
condition  at  this  time  must  show  the  item  Cash  to  be  less.  But  that 
is  not  the  only  change  in  the  situation  worked  by  this  loss.  The  total 
of  Property  is  decreased,  although  the  Claims  by  outsiders  remain  un- 
changed; there  is,  therefore,  less  property  left  to  represent  the  pro- 
prietor's interest.  The  proprietorship  item  in  the  statement,  then, 
should  be  decreased  much  as  it  was  increased  above.  In  this  example 
there  has  been  a  decrease  to  both  sides  of  the  statement,  whereas  in 
the  preceding  one  there  was  an  increase  to  both  sides. 

3 — Wells  pays  $200  in  partial  discharge  of  his  debt  to  Blank  Auto 
Co. 

Financial  Transactions.  It  is  easy  to  see  the  effect  of  transac- 
tions upon  the  cash;  the  payment  would,  of  course,  decrease  the 
Cash.  Likewise,  part  payment  to  Blank  Auto  Co.  would  leave  a 
smaller  debt  to  be  paid  later.  If  the  statement  is  to  express  the  true 
financial  condition  at  this  time,  Cash  and  Debts  Payable  must  both 
be  altered.  This  is  another  example  wherein  both  sides  of  the  state- 
ment are  decreased. 

4- — Wells  collects  $500  from   M.   Y.  Jones  in  partial  discharge  of 
$     the    latter's    debt. 

Here  cash  is  increased  by  the  amount  collected  and  Debts  Re- 
ceivable is  decreased.  Partial  payment  by  Jones  leaves  less  debt  "re- 

12 


ceivable"  by  Wells.  This  case  is  seen  to  present  a  decrease  to  one 
item  and  an  increase  to  another  on  the  same  side  of  the  statement. 
The  total  Property  is  nowise  changed;  there  has  only  been  a  conver- 
sion of  one  type  of  property  (debt)  into  another  (cash). 

5 — Wells'  bank,  at  his  request,  loans  the  business  $3,000. 

Cash  is  increased,  but  what  other  change  occurs  at  the  same 
time?  It  will  have  been  noticed  before  now  that  the  changes  always 
occur  in  pairs. 

Borrowing  always  carries  with  it  the  obligation  or  promise  to 
repay,  so  it  may  be  said  that  a  loan  gives  rise  to  debt.  It  is  a  trans- 
action on  credit,  just  as  weynay  buy  merchandise  on  credit.  But 
"Borrow"  and  "Loan"  are  terms  generally  used  for  transactions  in 
cash,  while  "Buy"  and  "Sell"  usually  refer  to  transactions  in  mer- 
chandise or  property  other  than  cash. 

Thus,  while  borrowing  and  buying  on  credit  both  give  rise  to 
debts,  there  still  is  sufficient  difference  between  them  to  warrant  sepa- 
rate accounting.  Therefore,  in  altering  the  statement  for  this  trans- 
action, a  new  item  should  be  introduced  on  the  Claim  side,  namely, 
Loans  Payable.  This  item  is  shown  increased  from  zero  to  $3,000; 
and  again,  the  totals  of  the  statement  are  seen  to  be  equal,  although 
alterations  have  been  made  in  the  details. 

Recoverable  Outlay  Transactions.  The  investment  transactions 
involved,  among  others,  changes  to  the  Proprietorship  or  Present 
Worth  because  the  occurrences  were  seen  to  alter  the  amount  of  the 
owner's  claims  against  the  property.  The  financial  transactions  in- 
volved no  changes  whatever  in  Proprietorship,  being  merely  conver- 
sions of  one  property  into  another,  the  acquisition  of  additional  prop- 
erty from  outsiders  on  credit  or  the  application  of  property  to  the 
discharge  of  debts.  There  is  seldom  any  profits  or  losses  involved  in 
such  transactions.  No  examples  have  yet  been  studied  which  involved 
any  changes  in  Sales,  Purchases  or  Expenses.  Some  transactions  of 
this  type  will  now  be  examined. 

6 — Wells  bought  $500   worth   of   merchandise   for  cash. 

Cash  is  decreased,  and  that  item  on  the  Balance  Sheet  should  be 
changed  accordingly.  The  other  change  involves  the  Statement  of 
Profit  and  Loss.  There  has  now  been  an  additional  outlay  for  sal- 
able goods;  it  is  a  Recoverable  Outlay,  and,  being  in  the  first  of  the 

13 


two  classes  of  accounts  under  that  heading,  is  designated  Purchases. 
If  the  Statement  is  to  exhibit  the  true  profit,  all  Recoverable  Outlay 
must  be  included.  We  accordingly  alter  the  amounts  to  reflect  this 
increase  in  the  Purchases.  This  transaction,  it  will  be  noted,  expresses 
a  decrease  to  property  (Cash)  and  an  increase' to  Recoverable  Outlay 
(Purchases). 

7 — Wells  found  that  an  error  had  been  made  in  the  bill  of  goods 
bought  in  transaction  6.  It  now  appears  that  there  was  an  ov- 
erpayment of  $50,  which  amount  is  now  returned  to  Wells  in 
cash  by  the  seller. 

Cash  is,  of  course,  increased.  It  matters  not  what  the  reason 
may  be,  if  more  cash  is  on  hand  after  a  transaction  than  before,  that 
transaction  has  caused  an  increase  to  the  cash  item  in  the  statement. 

The  other  change  is  perhaps  not  so  readily  perceived.  A  moment's 
consideration,  however,  should  show  that  the  Purchases  item  in  the 
Statement  of  Profit  and  Loss  is  incorrect  in  view  of  the  latest  infor- 
mation, although  it  was  thought  to  be  correct  when  the  previous 
change  occurred.  If  Wells  has  received  back  $50  of  what  he  previ- 
ously paid  the  seller,  the  real  cost  of  the  Purchases  is  $450,  and  not 
$500,  as  recorded.  Therefore,  alter  the  Purchases  item  in  the  state- 
ment by  $50  and  the  true  profit  will  result ;  otherwise  it  will  be  clearly 
incorrect,  and  not  in  accord  with  the  actual  facts.  This  transaction 
is  an  example  of  the  case  involving  a  decrease  to  Recoverable  Outlay 
(Purchases)  and  an  increase  to  Property  (Cash). 

8 — Wells  paid  rent  of  storeroom  next  to  his  building  used  for 
storage  purposes,  $100. 

Cash  is  decreased;  Recoverable  Outlay  (Expenses)  increased. 
The  true  profit  can  not  be  shown  until  this  outlay  or  expense  shall 
have  been  shown  as  recovered  (deducted)  out  of  sales  along  with 
others.  The  paid  out,  recoverable  costs  are  carried  temporarily  in 
their  own  accounts,  and  later  deducted  out  of  Sales  in  a  lump  sum. 

9__Wells  sold  $900  worth  of  goods  to  P.  J.  Frank  on  credit. 

Here  is  an  increase  of  Debts  Receivable  (P.  J.  Frank)  and  an 
increase  to  Recovered  Outlay  (Sales)  :  This  new  term  is  in  a  way 
the  reverse  of  "Recoverable  Outlay";  it  expresses  an  accomplished 
fact  (i.  e.,  the  completion  of  a  sale)  ;  the  latter  term,  however,  looks 

14 


more  toward  the  future  (outlay  to  be  recovered).  One  term  expresses 
the  expectation;  the  other  the  fulfilment.  When  one  "lays  out"  funds 
in  the  form  of  purchases  of  salable  merchandise,  or  for  useful  serv- 
ices, he  "expects"  to  get  the  funds  back  eventually;  when  the  goods 
are  actually  sold  at  a  reasonable  price,  the  funds  are  then  actually  re- 
covered. It  is  this  idea  accounting  tries  to  express  and  record  in  the 
accounts  and  transactions  of  this  type. 

The  effect  upon  the  elements  of  the  statements  of  the  nine  trans- 
actions given  may  be  summarized  as  follows: 

1 — Increase  Property  (cash)  ;  Increase  Proprietorship. 

2— Decrease  Property   (cash)  ;   Decrease  Proprietorship. 

3 — Decrease  Property  (cash)  ;  Decrease  Outsiders'  Claims  (Debts 

Pay.). 

4 — Increase  Property   (cash)  ;  Decrease  Property  (Debts  Rec.). 
5 — Increase   Property    (cash)  ;   Increase  Outsiders'   Claims    (Loan 

Pay.). 
6 — Increase  Recoverable  Outlay    (purchases)  ;   Decrease  Property 

(cash). 
7 — Decrease  Recoverable  Outlay    (purchases)  ;   Increase  Property 

(cash). 
8 — Increase    Recoverable    Outlay    (expense)  ;    Decrease    Property 

(cash). 
9 — Increase   Property    (Debts  Rec.)  ;   Increase  Outlays  Recovered 

(sales). 

This  summary  should  dispel  any  idea  that  may  have  developed, 
as  it  sometimes  does,  that  one  of  the  two  changes  always  produced  by 
a  transaction  is  inevitably  an  increase  to  something,  while  the  other  is 
inevitably  a  decrease  to  something.  This  is  not  the  fact,  as  a  glance 
at  transaction  i,  2,  3,  5,  9  will  prove.  There  is  no  rule  so  simple  as 
that;  accounting  involves  real  thinking,  rather  than  merely  following 
a  rule.  Every  transaction  must  be  thought  out  by  itself. 

Transaction  Analysis.  The  topic  at  present  under  consideration 
is  one  of  the  most  important  presented  to  the  student  of  elementary 
accounting.  The  student  must  learn  to  analyse  business  transactions 
and  to  see  clearly  what  the  effect  of  each  one  is  upon  the  various  ele- 
ments of  the  business  enterprise.  If  the  occurrence  produces  an  in- 
crease to  one  element,  such  as  Debts  Receivable,  it  must  be  clearly 
recognized  as  such.  Any  confusion  or  wrong  assumption  will  surely 
be  reflected  in  the  statements.  And  if  they  are  wrong,  they  may  be 
wholly  misleading  to  every  one  who  attempts  to  use  them.  This  is 
an  important  point.  The  statements  must  be  made  correctly,  because 
the  business  man  depends  upon  them  to  tell  him  what  his  business  is 
doing. 

15 


The  question:  WHAT  IS  INCREASED  OR  DECREASED? 
should  be  always  uppermost  in  our  mind,  and  should  be  definitely 
answered  before  proceeding  further  with  a  given  transaction. 

The  question:  WHAT  OTHER  ELEMENT  IS  INVOLVED? 
should  always  be  answered  also  before  recording  the  change  produced 
by  any  transaction.  It  is  never  to  be  forgotten  that  every  transaction 
produces  two  changes.  Generally  one  of  them  at  least  is  quite  readily 
discovered,  but  often  it  requires  real  thinking  to  perceive  the  other; 
but  it  is  always  there. 

The  nine  typical  transactions  given  above  illustrate  the  method 
of  analyzing  and  thinking  out  transactions.  There  is  no  single  rule 
which  can  be  applied  to  any  and  all  transactions ;  analysis  is  a  method 
of  thinking  things  out,  and  not  a  method  of  merely  applying  a  set 
rule.  One  must  have  clearly  in  mind  the  purpose  of  it  all — the  prepa- 
ration of  true  financial  statements — and  then  see  to  it  that  no  part  of 
his  thinking  shall  lead  up  to  any  other  kind  of  statement.  With  the 
purpose  always  in  mi-nd,  he  must  look  deeply  into  and  behind  the 
facts  in  a  given  case,  to  the  end  that  their  true  meaning  shall  be 
clearly  seen,  and  their  real  effect  upon  the  elements  which  make  up 
the  statements  really  understood.  With  the  transaction  thoroughly 
understood,  and  the  effect  upon  the  statements  clearly  in  mind,  no  dif- 
ficulty will  be  experienced  in  doing  whatever  writing  or  other  routine 
may  be  necessary. 

PROBLEMS— CHAPTER  II. 

1.  Starting  with  the  statements  as  shown  on  page  n  and  con- 
sidering  the   changes   caused   by   the   several   transactions   thereafter 
discussed,  prepare  Balance  Sheet  and  Profit  and  Loss   Statement  to 
show  the  standing  of  the  business  after  all  of  the  transactions  had 
occurred.    Assume  that  all  goods  have  been  sold. 

NOTE  :  The  procedure  of  finding  the  true  amounts  which  make  up  the 
final  statements  in  this  problem  will  seem  somewhat  slow  and  clumsy,  for  many 
changes  will  have  to  be  made  by  erasure  or  by  crossing  off  the  items  changed. 
But  this  exercise  will  lead  to  a  clearer  appreciation  of  what  a  splendid,  orderly 
record  of  changes  the  ledger  really  is. 

2.  For  each  transaction  listed  below,  show  the  kind  of  things 
increased  or  decreased  thereby  in  the  manner  illustrated  on  page  15. 

1 — Baldwin  Southmore  began  his  new  business  with  the  invest- 
ment of  $14,000  cash,  $400  worth  of  fixtures  and  $600  deliv- 
ery truck. 

16 


2 — Bought   a   stock   of   merchandise,   $8,000  cash   and   $7,000   on 

credit  from  Harvey  Hart's  Brothers. 
3 — Purchased  a  second  delivery  car  on  credit  from  the  Storage 

Auto   Company,  $450. 

A — Sold  $2,000  worth  of  goods  to  James  Byer  on  credit. 
5 — Gave  Storage  Auto  Company  merchandise  $450  (selling  price) 

in  discharge  of   debt  to  them. 
6— Paid  Rent  of  Store,  $100. 

7 — Permanently  withdrew  $3,000  of  original  investment. 
8— Accepted  a  good  office  safe  worth  $300  to  apply  against  Byer's 

debt. 
9 — $500   worth    of   goods    from    Hart's    Brothers   are   not  up   to 

standard  quality  and  have  been  returned  to  them. 
10 — A  small  fire  destroyed  one  of  the  delivery  cars.     It  was  the 

originally  invested  one  and  was  not  insured. 
11— Borrowed  $2,000  from  the  bank. 
12 — Paid  Hart's  Brothers  $1,000  on  account. 
13 — Paid  wages  for  two  weeks,  $80. 
14 — Sold  remaining  merchandise  for  a  $15,000  store  property  and 

$8,000  cash. 
15 — Paid  $1,500  on  loan   from  the  bank. 

3.  Produce  the  statements  for  Southmore's  business  as  it  stood 
after  the  I5th  transaction. 

4.  Follow  instructions  for  Problem  2  above,  but  use  the  exer- 
cises from  text  book  which  the  teacher  will  indicate. 


I/ 


Ill 

THE  LEDGER 

In  the  previous  discussions,  two  principles  stand  out  clearly : 
first,  that  the  aim  of  accounting  is  to  make  Financial  Statements 
possible,  and  second,  that  the  statements  of  one  day  would  be  out  of 
date  the  next  because  of  the  business  transactions  which  had  taken 
place  in  the  meantime.  The  problem  next  to  receive  consideration  is 
this :  How  does  accounting  provide  the  means  of  systematically  re- 
cording transactions  so  that  statements  may  be  prepared  at  compara- 
tively long  intervals?  Previous  problems  will  have  shown  that  a  sys- 
tematic way  of  recording  transactions  is  very  necessary. 

It  will  be  readily  seen  that  the  procedure  outlined  in  the  last 
chapter  could  hardly  be  practiced  in  actual  business.  While  every 
separate  transaction  may  be  shown  to  produce  definite  changes  in  the 
statements,  and  thus  help  us  see  the  effect  of  transaction  upon  the 
business,  yet  to  attempt  in  practice  to  record  many  transactions  by 
successive  alterations  of  the  statements  would  soon  lead  to  confusion. 
The  proprietor  will  want  his  statements  only  at  certain  definite  inter- 
vals, say  at  the  end  of  each  month,  and  some  orderly  method  there 
must  be  for  systematically  recording  what  happens  during  the  month 
so  statements  can  be  prepared  when  needed  without  delay  or  con- 
fusion. 

The  problem  which  accounting  has  to  meet  involves  several 
factors.  Provision  must  be  made  for  recording  easily,  and  without 
danger  of  confusion,  any  possible  change  in  any  of  the  several  ele- 
ments of  the  statements ;  space  there  must  be  for  recording  the 
changes  occurring  in  a  period  of  some  length ;  care  must  be  taken  to 
avoid  errors  in  dealing  with  the  many  figures. 

The  Account.  Perhaps  the  first  suggestion  coming  naturally  to 
mind  upon  considering  the  factors  in  this  problem  would  be  that  the 
statements  be  spread  upon  a  sheet  sufficiently  large  to  permit  amounts 
to  be  neatly  added  to  and  deducted  from  the  separate  items.  But 
only  a  sheet  of  unreasonable  size  could  take  care  of  a  large  business. 
The  next  idea  advanced  might  well  be  that  a  page  in  a  book,  or  a  part 

18 


of  a  page,  be  assigned  to  each  of  the  several  elements  of  the  state- 
ments. Thus  there  could  be  a  Cash  Page,  a  Purchase  Page,  etc. 
Transactions  which  increased  Cash  could  easily  be  added  to  the  pre- 
vious figures  and  deductions  subtracted. 

Part  of  the  problem  seems  solved,  for  changes  could  be  easily 
recorded  on  the  separate  pages  without  confusion,  and  there  would 
be  space  for  a  considerable  period,  with  the  opportunity  of  carrying 
the  work  forward  to  other  pages  when  one  was  filled.  But  if  notice 
be  taken  of  the  great  number  of  small  problems  in  subtraction  and 
addition  that  would  be  necessary,  it  will  be  seen  that  little  provision 
has  been  made  for  avoiding  the  errors  naturally  attendant  upon  such 
arithmetic. 

We  see  at  once  that  a  change  in  any  element  of  a  business  could 
be  in  only  two  directions — increase  or  decrease.  The  cash,  for  ex- 
ample, could  be  only  added  to  or  subtracted  from.  Therefore,  the 
idea  comes  to  mind  at  once  that  most  of  the  adding  and  subtracting 
of  separate  transactions  could  be  eliminated  by  dividing  the  page 
vertically  down  the  middle  and  recording  on  one  side  only  those  trans- 
actions which  increased  the  total  of  that  page,  and  on  the  other  only 
the  decreasing  transactions. 

The  Cash  Page,  if  kept  thus,  would  look  like  this : 


Cash 


(Increase   side) 
June      1 — Balance   on   hand  at 

beginning    $5,000 

7— from  Smith  &  Co...      700 


June 

June 

Tune  13 — from 

June  17— from  H.  T.  Peters..      800 


9 — from  A.  J.  Jones ...      500 
R.  P.  Clark..        300 


(Decrease  side) 

rune  1— to  Marvel  Flour  Mills.. $900 
rune  3— to  Hart   Produce  Co. . .  600 

rune  4 — to  clerk  for  wages 75 

l"une  7— to  landlord  for  rent. ...   200 


In  this  arrangement  we  have  an  account :  in  a  way,  a  story.  A 
narrative  is  sometimes  called  "an  account";  the  above  example  is 
really  a  narrative  of  the  changes  occurring  in  the  Cash,  hence  the 
title,  Cash  "Account".  Other  account  names  are  given  in  the  same 
way,  such  as  Sales  Account,  P.  J.  Frank's  Account,  etc. 

That  the  arrangement  of  financial  facts  in  account  form  really 
decreases  the  chance  of  arithmetical  error  will  be  apparent  in  the 
above  example.  In  order  to  find  the  amount  of  cash  on  hand  on  the 
last  day  shown,  (i)  add  together  the  entries  on  the  left,  (2)  add  to- 
gether the  entries  on  the  right,  (3)  subtract  the  smaller  of  the  two 
sums  from  the  larger.  The  result  will  be  the  Balance  of  Cash  on 


19 


June  17.  if  we  successively  added  and  subtracted  each  entry  from 
the  opening  Balance,  there  would  be  eight  calculations  to  be  per- 
formed, each  one.  offering  a  chance  of  error.  There  is  a  saving,  too, 
in  time  in  the  account  form,  because  of  the  fewer  calculations. 

The  Ledger.     If  each  item  on  the  Financial  Statements  be  given 
a  page  or  part  of  a  page  in  this  manner,  the  result  would  be  a  book 
of  accounts  which  we  term  a  Ledger.     In  some  languages  the  term 
-is  equivalent  to  "Principal  Book",  which  describes  it  very  aptly. 

The  next  problem  is  to  get  the  Ledger  started  or  "opened"  as  the 
accounting  term  has  it.  The  process  of  opening  the  Ledger  would 
seem  simple  enough — merely  heading  up  the  pages  and  entering  the 
amounts  as  shown  on  the  first  statement* — if  it  were  not  for  the  fact 
that  one  must  decide  on  which  side  of  the  vertical  ruling  to  enter  the 
first  amounts  or  opening  Balances. 

This  will  require  some  little  explanation  and  no  little  study  to 
make  it  clear.  A  rough  outline  sketch  of  the  Ledger  is  shown  on  the 
opposite  page,  containing  as  opening  entries  the  amounts  given  in 
H.  R.  Wells'  statements  on  page  n. 

It  will  be  noted  that  in  the  Ledger  the  Purchases,  Sales  and  Ex- 
penses have  not  yet  been  combined  to  calculate  the  Net  Profit,  as  has 
been  done  on  the  statements.  It  follows,  therefore,  that  the  Proprie- 
tor's Investment  in  the  Ledger  will  not  yet  have  been  increased  by 
the  Net  Profit  as  it  has  .upon  the  finished  statement. 

The  other  important  point  to  be  explained  is,  why  some  of  the 
opening  balances  are  on  the  left,  while  others  are  on  the  right. 

By  leaving  a  blank  space  in  the  above  Ledger  (in  a  book  it  might 
be  several  pages),  a  division  is  marked  between  the  accounts  which 
come  from  the  Balance  Sheet  and  those  which  .come  from  the  State- 
ment of  Profit  and  Loss.  By  comparing  the  first  section  of  the  Led- 
ger with  the  Balance  Sheet,  it  will  be  observed  that  all  of  the  amounts 
on  the  left  (Property)  side  of  the  latter  became  opening  entries  on 
the  left  side  of  the  accounts  in  the  Ledger;  all  of  the  amounts  on  the 
right  (Claims)  side  became  opening  entries  on  the  right  side  of  the 
Ledger  accounts.  This  arrangement  prevails,  not  by  coincidence,  but 
by  intention.  The  reason  is  that  we  shall  wish  later  to  produce  a  Bal- 
ance Sheet  from  the  facts  in  the  Ledger.  It  will  aid  us  in  transcrib- 


*The  first  statements,  if  no  accounting  hooks  had  been  kept,  would  have 
to  be  compiled  from  an  inspection  and  valuation  of  the  property  and  by 
reference  to  whatever  unrelated  memoranda  were  available. 

20 


ing-  correctly  the  amounts,  if  they  are  found  in  the  Ledger  on  the 
same  side,  left  or  right,  as  they  are  to  be  placed  upon  the  Balance 
Sheet.  Hence,  in  opening  the  Ledger  for  the  first  time,  the  amounts 
are  intentionally  placed  as  shown  above,  left  and  right. 


H.  R.  WELLS  LEDGER 


Cash 


$7,000 


M.  T.  Jones 


$1,700 

P.  J.  Frank 
$500 

Land  and  Bldgs. 
$9,000 

Store  Furniture 


$800 

Delivery   Auto 


$1,500 


Blank  Auto   Co. 


$500 


H.  R.  Wells— Invest. 


$17,800 


Purchases 
$4,000 

Expenses 
$800 


Sales 


$7,000 


21 


The  arrangement  of  the  opening  entries  coming  from  the  State- 
ment of  Profit  and  Loss  is  not  so  readily  explained.  But  it  can  be 
placed  on  a  basis  similar  to  the  first  part  of  the  Ledger  by  referring 
to  an  older  form  of  Profit  and  Loss  Statement. 

It  was  the  custom,  until  recent  years,  to  report  the  Statement  of 
Profit  and  Loss  in  the  following  form: 

STATEMENT  OF  PROFIT  AND  LOSS  (old  form) 

Purchases    $4,000  Sales    $7,000 

Expenses    800 


$4,800 
Balance  being  Net  Profit 2,200 


$7,000  $7,000 

This  original  form  of  the  Profit  and  Loss  Statement  is  seen  to 
conform  to  the  arrangement  of  the  Balance  Sheet  by  having  the  facts 
tabulated  in  two  columns,  left  and  right.  One  using  this  style  of 
statement  would  find  it  an  aid  in  transcribing  the  facts,  if  the  figures 
were  to  be  found  in  the  Ledger  on  the  same  side  as  they  were  to  ap- 
pear on  the  statement.  In  opening  the  Ledger,  then,  the  amounts  were 
intentionally  entered  as  shown  in  the  Ledger  above,  Purchases  and 
Expense  balances  on  the  left  and  Sales  on  the  right,  and  the  custom 
remains. 

Classification  of  Accounts.  With  the  Ledger  opened,  the  next 
point  concerns  itself,  with  making  additional  entries  therein  to  record 
the  financial  changes  that  take  place.  The  first  question  would  logic- 
ally be:  Which  side  of  these  accounts  receives  the  increases  and 
which  the  decreases  as  the  transactions  are  entered? 

This  is  easily  answered  for  those  accounts  which  enter  the  Ledger 
when  it  is  first  opened:  Any  increase  would  be  entered  on  the  -same 
side  as  the  opening  balance;  any  decrease,  on  tJw  side  opposite  the 
opening  balance* 

After  a  Ledger  has  been  opened,  however,  new  accounts  are  be- 
gun as  occasion  requires,  and  for  these  there  must  be  some  way  of 
determining  the  increase  and  decrease  side.  All  accounts  are  divisible 
into  classes,  and  according  as  one  account  falls  into  one  class  or  an- 
other its  plus  and  minus  characteristics  are  determined.  So  the  quick- 
est way  to  get  at  the  matter  is  to  learn  how  accounts  are  classified 


*This  peculiar  practice  in  accounting  of  expressing  a  subtraction  by  an 
opposing  entry  should  never  be  lost  sight  of. 

22 


into  groups,  and  to  learn  to  recognize  new  accounts  by  assigning  them 
to  their  appropriate  group. 

The  first  subdivision  of  accounts  marks  out  two  great  classes: 

I.     Real  accounts. 
II.     Nominal  accounts. 

Every  account  belongs  under  one  of  these  two  heads.  Any  ac- 
count which  may  properly  be  shown  in  the  Balance  Sheet  is  a  Real 
account,  for  it  usually  stands  for  some  real,  existing  thing,  or  some 
lawful,  enforcible  right,  as:  Cash,  stands  for  money  in  the  drawer; 
Furniture,  for  the  desks,  etc.,  or  as  Debts  Receivable  stand  for  the 
enforcible  right  to  have  the  debt  paid. 

Any  account  which  may  properly  be  shown  in  the  Profit  and 
Loss  Statement  is  a  Nominal  account,  for  it  represents  not  a  thing, 
but  a  name — a  mere  idea.  Sales,  for  example,  does  not  call  to  mind 
any  actual  thing  as  would  Cash;  it  calls  to  mind  only  a  "goods-sold- 
idea",  if  we  may  so  express  it.  Expense  calls  to  mind  a  "services- 
consumed-idea".  A  sale  is  not  a  thing  like  Cash  or  a  right  like  a 
Debt,  but  merely  a  count  of  "disposed-of-merchandise".  Expense  is 
merely  a  count  of  "used-up-services". 

Each  of  these  groups  is  in  turn  divided : 

I.     Real  accounts. 

I.     Assets.  2.     Liabilities. 

II.     Nominal  accounts. 

I.     Recoverable  Outlays.         2.     Recovered  Outlays. 

The  subdivisions  of  Group  II  are  already  familiar,  but  the  sub- 
division of  Real  accounts  (Group  I)  reveals  two  new  names.  "As- 
sets" is  a  technical  term,  the  nearest  synonym  for  which  is  Property. 
Thus  in  a  technically  correct  Balance  Sheet  (and  Ledger  as  well) 
certain  elements  are  termed  Assets  which  we  have  called  Property 
until  now.  By  an  Asset  we  will  now  understand  any  valuable  thing 
or  right  which  is  serviceable!  to  the  operation  of  business,'  or  which 
possesses  value  in  the  sense  that  cash  could  be  obtained  for  it. 

The  term  "Liabilities"  is  now  to  replace  "Claims"  in  our  state- 
ments to  make  them  technically  correct.  The  two  terms  have  much 
the  same  significance;  the  difference  is  largely  one  of  point  of  view. 
A  debt  that  we  shall  soon  have  to  pay  may  be  regarded  as  a  Liability, 
(i.  e.,  as  an  obligation,  a  burden),  or  as  a  Claim  (i.  e.,  a  right  another 

23 


has  against  us),  depending  upon  whether  we  choose  to  look  at  it  from 
our  own  point  of  view  or  from  another's.* 

A  diagram  will  help  to  get  these  matters  related  in  our  minds 
in  an  orderly  manner.  The  Ledger  may  be  represented  as  the  two 
statements  greatly  expanded  as  to  space. 

LEDGER 

REAL  ACCOUNTS— (i.  e.,   Balance   Sheet  accounts) 
Asset  Accounts  Liability  Accounts 


NOMINAL  ACCOUNTS— (i.  e.,  Profit  and  Loss  Statement  accounts) 
Recoverable  Outlay  Accounts  Recovered   Outlay  Accounts 


The  headings  in  this  diagram  are,  of  course,  merely  explanatory, 
and  do  not  appear  in  an  actual  Ledger. 

Increases  and  Decreases.  The  important  characteristics  of  these 
several  classes  of  accounts  now  to  be  stated  should  be  thoroughly 
learned  and  every  effort  made  to  use  them  consistently  in  subsequent 
exercises. 


*Proprietorship  is  clearly  recognized  as  a  claim  against  assets,  but  there 
are  those  who  profess  inability  to  conceive  of  it  as  a  liability  of  the  business. 
The  average  business  man,  however,  and  the  average  student  experiences  no 
difficulty  in  thinking  of  the  Business  as  distinct  from  the  Proprietor  and 
therefore  can  clearly  conceive  of  the  Business  (typified  by  the  Balance  Sheet) 
as  liable  to  the  Proprietor  for  his  Invested  Capital  and  the  accumulated  profits. 
But  it  should  never  be  overlooked  that  the  Proprietor's  claim  is  always 
secondary  to  that  of  outside  creditors. 

24 


All  accounts  representing  Assets  or  Recoverable  outlays  are 
increased  by  entries  on  the  left  side  and  decreased  by  entries  on 
the  right. 

All  accounts  representing  Liabilities  and  Recovered  Outlays 
are  increased  by  entries  on  the  right  side  and  decreased  by  entries 
on  the  left. 

Although  the  above  statement  of  principle  should  be  memorized, 
the  following  arrangement  may  help  to  call  the  facts  to  mind : 

LEFTSIDE —  RIGHTSIDE — 

Increases  to  Asset  accounts.  Decreases  to  Asset  accounts. 

Increases    to    Recoverable    Outlay  Decreases    to    Recoverable    Outlay 

accounts.  accounts. 

Decreases  to  Liability  accounts.  Increases  to  Liability  accounts. 

Decreases     to     Recovered     Outlay  Increases  to  Recovered  Outlay  ac- 

accounts.  counts. 

By  applying  these  principles  it  will  now  be  possible  not  only  to 
open  a  Ledger  if  required,  but  also  properly  to  make  subsequent  en- 
tries therein  to  record  any  changes  that  occur  in  the  elements  of  the 
business  thereafter.  The  Ledger  will  then  become  a  concise  but  very 
complete  record  of  the  condition  and  progress  of  the  business. 

Making  Entries.  When  preparing  to  make  entries  after  the  Led- 
ger has  been  opened,  one  must  answer  three  questions  regarding  each 
transaction : 

1.  Which  two  accounts  are  changed  by  this  transaction? 

2.  Are  those  accounts  increased  or  decreased? 

3.  Does  the  entry,  therefore,  fall  upon  the  left  or  right  side? 
The  first  two  questions  can  be  answered  only  by  thinking  over 

the  accounts  in  use  and  the  meaning  of  the  transaction.  If  the  sev- 
eral accounts  being  used  do  not  come  readily  to  mind,  a  list  of  them 
should  be  looked  over,  and  the  proper  ones  involved -chosen  therefrom. 
The  meaning  of  the  transaction  must  be  understood  perfectly  or 
correct  entries  will  be  impossible.  If  it  is  said  that  a  delivery  car  is 
purchased,  it  must  be  clearly  perceived  that  the  element  of  the  busi- 
ness called  Delivery  Equipment  is  increased,  and  not  Purchases.  The 
latter  is  a  technical  term  meaning  "Purchases  of  merchandise  for  re- 
sale only";  it  is  not  so  broad  in  meaning  in  accountancy  as  in  ordi- 
nary conversation.  Should  the  car  be  sold  later,  Delivery  Equipment 

25 


would  be  decreased,  for  the  acounts  must  always  show  by  their  bal- 
ances the  present  state  of  affairs. 

If  the  transaction  states  that  a  Debt  Receivable  or  a  Debt  Pay- 
able is  paid,  we  must  understand  that  "paid"  does  not  always  refer 
to  cash.  The  word  is  more  in  the  sense  of  "discharged",  and  there- 
fore may  be  used  to  indicate  a  decrease  to  Debts  from  whatever  cause. 
Thus  goods  returned  could  cause  a  decrease  to  Debts  as  properly  as 
would  cash ;  a  promissory  note  would  discharge  a  previously  contracted 
debt  by  taking  the  place  of  the  oral  agreement.  These  examples  suf- 
fice to  show  that  transactions  must  be  studied  thoughtfully. 

As  one  gains  experience  in  analyzing  transactions,  the  customary 
and  oft-repeated  ones  grow  very  familiar,  and  interpretation  is  very 
easy.  But  new  and  unfamiliar  transactions  are  constantly  coming  to 
notice  which  must  be  reasoned  out  step  by  step  as  suggested. 

With  the  first  two  questions  satisfactorily  covered,  the  third  can 
be  answered  by  referring  the  transaction  to  the  rules  of  increase  and 
decrease  given  in  connection  with  the  classification  of  accounts.  One 
needs  only  decide  to  which  class  belong  the  accounts  in  question  i, 
and  recall  whether  the  increases  to  that  class  fall  upon  the  left  or 
the  right  side.  So  to  decide  necessitates  a  thorough  understanding  of 
the  characteristics  of  each  class  of  accounts,  as  given  in  a  previous 
chapter,  and  an  ability  instantly  to  recall  the  general  rule  of  plus  and 
minus. 

PROBLEMS— CHAPTER  III. 

i.  Analyze  the  several  typical  transactions  for  H.  R.  Wells' 
business  in  Chapter  II,  to  determine  which  side  of  specific  accounts 
should  receive  for  each  one.  Be  prepared  to  answer  the  three  ques- 
tions on  page  26  for  each  transaction.  For  convenience,  record  the 
results  of  your  study  of  each  transaction  like  this : 

Cash  account  Sales  account 


transaction  (1)  $700 


transaction  (1)  $700 


2.  Follow  instructions  for  problem  i  above,  but  use  the  trans- 
actions of  problem  2,  Chapter  II   (Southmore's  business).     Save  the 
solution  of  this  problem  for  future  use. 

3.  Follow  the  same  instructions,  using  such  exercises  from  text 
book  as  the  teacher  may  indicate. 

26 


IV. 
TRIAL  BALANCE  AlND  STATEMENTS 

In  an  earlier  chapter  we  saw  how  the  statements  were  made  in  a 
form  to  show  a  left  and  a  right  side  with  equal  totals.  We  will  take 
another  example: 

BALANCE  SHEET— H.  K.  BROWN 

Assets  Liabilities 

Cash    $    800  Debts    Payable $1,100 

Debts  Receivable 1,200  Notes    Payable ..      300 

Notes    Receivable 700  *H.  K.   Brown,   Capital 5,900 

Lands   and  Bldgs 3,500 

Delivery   Equipment 900 

Store   Fixtures..  200 


$7,300  $7,300 


A  Ledger  opened  from  the  facts  shown  on  the  above  Balance 
Sheet  of  H.  K.  Brown  would  also  present  equal  totals,  as  the  illus- 
tration on  the  following  page  will  show. 

* 

These  totals  need  not  be  shown  in  an  actual  Ledger.  The  Sales, 
Purchases  and  Expense  accounts  are  blank  as  yet,  since  it  is  assumed 
that  the  business  is  just  now  starting. 


*A  new  term  is  here  introduced.  The  Proprietor's  claim  against  the 
assets  is  termed  his  Capital  Investment,  or  simply  his  Capital.  It  is  ordi- 
narily the  amount  he  put  in  originally  to  start  the  business.  It  may  be 
increased  by  putting  in  more  property  of  any  kind,  or  decreased  by  taking 
property  away  permanently.  To  be  technically  correct  his  account  in  the 
ledger  should  be  headed  as  here  shown  in  this  balance  sheet. 


27 


Cash 


Debts  Receivable 


$1,200 


Notes  Receivable 


$700 

Land  and  Buildings 
$3,500 

Delivery    Equipment 


$900 


Fixtures 


$200 


Purchases 


Expense 


$7,300,  Total  of  entries  on  left. 


Debts   Payable 


$1,100 


Notes   Pay. 


$300 


H.  K.  'Brown,  Cap. 


$5,900 


Sales 


Total  of  entries  on  right,  $7,300 


28 


If  we  were  now  to  reverse  the  process  and  take  off  a  list  of  the 
accounts  and  amounts  shown  by  the  Ledger,  we  would  have  simply 
the  Balance  Sheet  again,  but  without  its  headings. 

Let  us  analyze  a  few  transactions,  enter  them  in  the  Ledger,  and 
note  the  effect  upon  the  equality  of  the  totals. 


Transactions 

1 — Collected  cash  $200  from  a  Debt  Receivable.  i 

2— Paid  cash  $100  on  a  Debt  Payable. 

3 — Bought  merchandise  on  credit  $700. 

A — Paid  clerk  $40  for  wages. 

5— Sold  all  of  the  merchandise  for  cash,  $1,200. 

These  transactions,  when  analyzed  as  outlined  in  the  previous 
chapter,  will  show  certain  accounts  to  be  increased  and  others  de- 
creased; some  entries  for  these  transactions  would  be  to  the  left  side 
of  the  accounts,  some  to  the  right.  Arranged  in  tabular  form,  the 
analysis  gives  the  following  results : 


Entry  on  Left  Entry  on  Right 

Trans.  1— Cash   $   200  Debts  Rec $    200 

Trans..  2— Debts    Pay 100  Cash    100 

Trans.  3— Purchases    700  Debts   Pay 700 

Trans.  4 — Expense     40  Cash    40 

Trans.  5— Cash    .  .   1,200  Sales    .  .   1,200 


$2,240  $2,240 

The  student  should  analyze  each  of  these  transactions  himself  to 
see  if  he  comes  to  the  same  conclusion  as  shown  above. 

Transactions  Entered.  From  this  tabulation  it  is  an  easy  step 
to  enter  the  facts  in  the  Ledger.  The  accounts  in  the  Ledger  will 
then  appear  as  shown  on  the  following  page. 


29 


Cash 


Debts  Payable 


Original  $  800 
Trans.  1  200 
Trans.  5  1,200 


Trans.  2       $100 
Trans.  4          40 


Trans.  2   $    100 


Original  $1,100 
Trans.  3   $    700 


Debts  Receivable 


Original  $1,200 


Trans.  1    $   200 


Notes  Payable 


Original  $    300 


Notes  Receivable 


Original  $    700 


H.  K.  Brown,  Capital 


Original  $5,900 


Land  and  Buildings 


Original  $3,500 


Delivery  Equipment 


Original  $    900 


Fixtures 


Original  $   200 


Purchases 


Trans.  3    $    700 


Sales 


Trans.  5   $1,200 


Expense 


Trans.  4  $      40 


30 


Now  to  test  the  equality  of  totals  after  entries  have  been  made, 
the  following  list  is  prepared  from  the  Ledger  as  it  stands : 

LIST  OF  ACCOUNTS 

Left  Side  Right  Side 

Cash    $2,200                      $    140 

Debts   Receivable 1,200                           200 

Notes  Receivable 

Land  and  Buildings 3,500 

Delivery   Equipment 900 

Fixtures    200 

Purchases    700 

Expense   40 

Debts    Payable 100                        1,800 

Notes    Payable 300 

H.  K.  Brown,   Capital 5,900 

Sales    .  1,200 


$9,540  $9,540 

The  totals  are  seen  to  be  equal.  It  is  but  another  illustration  of 
the  old  proposition  that  equals  added  to  equals  produce  equals.  If 
we  take  the  totals  of  the  Balance  Sheet,  or,  what  is  the  same  thing, 
the  totals  of  the  Ledger  just  after  opening,  and  to  them  add  the  totals 
of  the  transactions  as  they  were  tabulated  above,  we  would  have  the 
totals  of  the  Ledger  after  the  transaction  entries  were  made,  i.  e.,  the 
totals  just  derived  in  the  above  list  of  accounts. 

Left  Right 

Totals  in  Ledger  at  opening  (p.  28) $7,300          $7,300 

Transaction  totals  (p.  29) 2,240  2,240 


Totals  from  Ledger  after  entries   (p.  31) $9,540  $9,540 

Where  business  transactions  are  numerous  and  the  Ledgers  large, 
such  a  test  of  the  entering  is  a  frequent  necessity.  Figures  may 
easily  be  copied  incorrectly,  or  even  entered  on  the  wrong  side  of  the 
account.  This  causes  the  Ledger  record  to  contain  untrue  statements 
of  fact,  and  occasional  tests  are  advisable  in  order  that  errors  may 
be  detected  and  corrected. 

The  list  of  accounts  which  affords  this  test  is  given  the  technical 
name  of  Trial  Balance.  It  is,  indeed,  a  trial  of  the  Ledger,  to  see 
if  it  is  in  balance  or  equilibrium ;  that  is,  in  a  condition  of  equality 
of  totals.* 


*It  is  often  thought  desirable  to  list  in  the  Trial  Balance  only  the  bal- 
ances of  the  several  accounts  rather  than  both  sides.  This  is  perfectly 
proper  once  the  theory  of  the  Trial  Balance  is  thoroughly  understood. 

31 


Debit  and  Credit.  We  are  to  note,  in  passing,  two  other  tech- 
nical terms  much  used  throughout  accounting.  It  will  have  been  no- 
ticed, that  the  left  and  right  sides  of  the  Balance  Sheet,  of  the  ac- 
counts, of  the  Trial  Balance,  etc.,  often  enter  into  the  discussion. 
Custom  has  assigned  the  name  Debit  to  the  left  side  wherever  it  is 
spoken  of  and  Credit  to  the  right  side.  Thus,  for  example,  we  speak 
of  the  debit  side  of  the  Cash  account,  referring  thereby  to  the  left 
side;  we  refer  to  the  right  side  of  the  Cash  account  always  by  the 
term  credit  side.  Sometimes  the  terms  are  abbreviated — Dr.  and  Cr. 

These  terms  are  decidedly  convenient  because  of  the  ease  with 
which  they  may  be  used  as  noun,  adjective  or  verb.  We  may  say: 
This  is  the  debit  side  of  the  account,  using  "debit"  as  an  adjective  to 
define  "side".  We  may  say:  This  is  a  debit  for  the  Cash  account, 
meaning  an  item  which  must  be  entered  on  the  left  (debit)  side  of 
Cash.  Here  the  term  is  used  as  a  noun.  Again,  it  may  be  used  as  a 
verb  to  indicate  an  action,  as  when  we  say:  I  debit  this  to  Purchases 
account,  meaning,  I  place  this  upon  the  debit  side  of  the  account. 

Because  Debit  invariably  refers  to  the  left  and  Credit  to  the  right, 
and  because,  as  we  have  seen,  the  two  sides  of  the  Balance  Sheet  are 
always  equal,  as  well  as  the  two  sides  of  every  transaction,  and  the 
two  sides  of  the  Ledger  and  the  Trial  Balance,  we  are  not  surprised 
to  find  in  accountancy  an  axiom  which  states — 

Debits  and  Credits  are  always  equal. 

This  axiom  has  a  more  important  bearing  later  than  just  now,  for 
later  we  shall  see  transactions  which  involve  one  debit  and  two  credits ; 
the  two  credits  added  must  then  be  equal  to  the  one  debit. 

The  Statements.  Besides  affording  a  ready  test  of  the  accuracy 
with  which  amounts  have  been  entered  to  the  debit  and  credit  of  the 
accounts,  the  Trial  Balance  is  a  convenient  summary  of  the  contents 
of  the  Ledger  from  which  to  construct  the  financial  statements  at  the 
end  of  a  period. 

We  have  to  think  of  the  Ledger  as  a  single  page  statement  ex- 
panded into  a  book,  and  as  being  subject  to  constant  change  from  the 
entries  therein.  The  form  never  changes;  only  the  amounts.  The 
Ledger,  then,  is  ready  at  all  times  to  be  reconverted  into  statements, 
and  the  statements  shall  then  reflect  the  changes  occurring  since  the 
Ledger  was  opened,  or  since  the  last  statements  were  prepared.  The 

32 


Trial  Balance,  then,  being  a  summary  of  trie  Ledger,  contains  all  of 
the  elements  necessary  to  form  the  new  statements.  Indeed,  the  state- 
ments are  but  the  Trial  Balance  items  re-grouped  to  form  the  Balance 
Sheet  and  the  Profit  and  Loss .  Statement. 

A  good  method  of  procedure  in  transforming  a  Trial  Balance 
into  the  financial  statements  is,  first,  to  mark  in  the  margin  opposite 
each  item  a  letter  to  indicate  the  class  of  accounts  it  belongs  to.  If 
we  use  "A"  for  Asset,  "L"  for  Liability,  "RO"  for  Recoverable  Out- 
lay, and  "Rd"  for  Recovered  Outlays,  H.  K.  Brown's  Trial  Balance 
would  be  marked  as  follows : 

TRIAL  BALANCE— H.  K.   BROWN 

Dr.  Cr. 

A      Cash    $2,060 

A      Debts    Receivable 1,000 

A      Notes   Receivable 700 

A      Land  and  Buildings 3,500 

A      Delivery    Equipment 900 

A      Fixtures 200 

RO  Purchases    700 

RO  Expense    40 

L       Debts   Payable $1,700 

L       Notes  Payable 300 

L      H.   K.   Brown— Capital 5,900 

Rd    Sales    1,200 


$9,100          $9,100 

Where  statements  are  to  be  made  from  the  Trial  Balance,  as  is  usually 
the  case,  it  is  well  to  have  the  Trial  Balance  consist  of  account  balances  as 
above  rather  than  of  both  sides  of  each  account. 

With  the  Trial  Balance  thus  marked  in  the  margin  it  is  not  a 
difficult  matter  to  assemble  all  items  marked  "A"  into  one  column, 
and  those  marked  "L"  into  a  parallel  column,  with  proper  headings, 
to  form  the  Balance  Sheet.  It  will  be  observed  that  in  lettering  the 
Trial  Balance  we  must  have  very  clearly  in  mind  the  distinction  be- 
tween Real  and  Nominal  accounts  and  between  the  four  sub-classes 
of  accounts,  so  that  each  item  will  be  properly  labeled. 

When  the  Real  accounts  have  been  transferred  from  the  Trial 
Balance  to  the  Balance  Sheet,  taking  care  to  check  off  each  item  as 
transferred  so  none  shall  be  missed,  then  the  Profit  and  Loss  State- 
ment is  constructed  from  the  Nominal  accounts.  When  that  is  com- 
pleted, see  that  all  accounts  on  the  Trial  Balance  are  checked.  Re- 
member, too,  that  the  old  form  of  Profit  and  Loss  Statement,  while 
an  excellent  aid  in  making  explanation  of  theory,  is  no  longer  the 
preferable  arrangement. 

33 


Following  these  suggestions,  the  statements  from  the  above  Trial 
Balance  would  be  as  follows : 

BALANCE  SHEET— H.  K.  BROWX 

Assets  Liabilities 

Cash    $2,060         '   Debts    Payable $1,700 

Debts  Receivable 1,000  Notes  Payable 300 

Notes    Receivable 700  H.  K.  Brown,  Capital 5,900 

Land  and  Buildings 3,500 

Delivery   Equipment 900 

Fixtures    200 


$8,360  $7,900 

PROFIT  AND  LOSS  STATEMENT 

Sales  $1,200 

Purchases    .  700 


Gross   Prolfit 500 

Expenses 40 


Net  Profit 460 

Profit  and  Capital.  It  will  be  observed  that  the  Real  accounts 
from  the  Trial  Balance  are  not  quite  enough  to  bring  the  two  sides 
of  the  Balance  Sheet  into  equilibrium.  This  interesting  point  deserves 
some  little  consideration.  We  will  find  it  helpful  to  look  more  closely 
into  the  nature  of  the  Proprietor's  Capital  Investment. 

If  we  assume  that  Mr.  Brown's  Balance  Sheet  on  page  27  was 
dated  January  i,  1920,  and  that  the  transactions  on  page  29  occurred 
during  the  month  of  January,  it  will  follow  that  the  Trial  Balance  on 
page  33  and  the  statements  made  therefrom  would  be  dated  February 
i,  1920.  Now  looking  at  H.  K.  Brown's  Capital  item  in  the  January 
i  and  the  February  i  Balance  Sheets,  we  find  them  the  same  in 
amount.  It  would  seem  from  this  that  Mr.  Brown's  interest  in  the 
Assets  was  no  more  now  than  a  month  ago.  But  let  it  be  noted  that 
the  Profit  and  Loss  Statement  clearly  shows  the  business  has  earned 
a  profit  during  the  month — which  is  to  say,  it  has  more  Assets  than 
before.  To  whom  would  the  increase  in  Assets  (i.  e.,  the  Profit)  be- 
long if  not  to  the  proprietor,  whose  invested  capital  and  guiding  hand 
has  made  the  profit  possible?  No  one  has  a  better  claim;  the  pro- 
prietor's investment  and  his  efforts  give  him  the  right  to  the  gains 
arising  therefrom.  Evidently  Mr.  Brown's  claim  against  the  Assets 
on  February  i  is  more  than  the  $5,900  capital  he  originally  put  into 
the  business ;  his  claim  now  really  consists  of  his  Investment  plus  any 
profits  gained  by  the  business. 

34 


This  reasoning  is  supported  by  the  figures.  There  are  $8,360 
in  Assets ;  of  this  total,  $2,000  ($1,700  plus  $300)  is  claimed  by  out- 
siders; the  remainder,  $6,360  ($8,360  less  $2,000),  would  naturally  be 
claimed  by  the  proprietor  as  his  own.  In  other  words,  the  proprietor 
will  claim  whatever  Assets  are  not  necessary  to  protect  outsiders.  This 
remainder  of  Assets  has  a  technical  term — Net  Worth.  The  net  worth 
of  this  business  on  February  i,  then,  is  $6,360.  But  looking  back  to 
the  January  I  Balance  Sheet  it  is  found  that  the  corresponding  figure 
(Net  Worth,  or  Proprietor's  Capital)  was  $5,900. 

This  means  that  a  sale  of  the  business  on  January  i  would  net 
the  proprietor  $5,900,  and  that  a  sale  on  February  i  would  net  him 
$6,360.  It  is  clear  that  changes  have  taken  place  during  the  month 
which  are  very  favorable  to  Mr.  Brown.  Since, he  has  not  put  in  any 
more  of  his  own  money  to  increase  his  net  worth,  it  follows  that  the 
increase  must  have  come  from  the  operations  of  buying  and  selling 
merchandise.  A  glance  at  the  Profit  and  Loss  Statement  shows  this 
to  be  the  case.  The  Profit  there  calculated  is  $460;  the  increase  in 
Net  Worth  from  January  i  to  February  i  is  found  to  be  $460  ($6,360 
on  February  i  less  $5,900  on  January  i).  The  amounts  agree  and  the 
statements  agree. 

Some  of  these  important  points  may  be  summarized  as  follows : 

1 — The  Net  Worth  of  a  business  is  the  difference  between  its 
Assets  and  its  Liabilities  to  outsiders. 

2 — The  difference  between  the  Net  Worth  at  two  different  dates 
should  show  the  same  net  profit  or  loss  on  the  Profit  and  Loss 
Statement,  allowances  being  first  made  for  any  additional  in- 
vestment of  capital  or  withdrawal  thereof. 

3 — The  Capital  from  the  previous  Balance  Sheet  plus  the  net 
profit  (or  minus  the  loss)  from  the  present  Pro/fit  and  Loss 
Statement  will  give  the  new  capital  (or  Net  Worth)  for  the 
present  Balance  Sheet. 

4 — If  the  Profits  be  added  to  (or  losses  deducted  from)  the  previ- 
ous Capital  and  the  resulting  figure  shown  on  the  current  Bal- 
ance Sheet  the  latter  statement  will  balance. 

The  statements  presented  above  are  now  shown  again  and  brought 
into  agreement— tied  together,  in  a  way,  by  having  the  Net  Profit 
from  the  Profit  and  Loss  Statement  added  into  the  Balance  Sheet. 


,  BALANCE  SHEET 

As  of  February  1,  1920 

Assets  Liabilities 

Cash $2,060  Debts   Payable $1,709 

Debts  Receivable 1,000  Notes  Payable 300 

Notes  Receivable 700  H.  K.  Brown,  Capital, 

Land  and   Buildings 3,500  January  1 $5,900 

Delivery  Equipment 900  Add  Profit  from  Profit 

Fixtures    200  &LossStm...                 460 


Net  Worth,  Feb.   1 6,360 


_$8,360  $8,360 

PROFIT  AND  LOSS  STATEMENT 
For  Month  of  January,  1920 

Sales $1,200 

Purchases   „ 700 

Gross   Profit 500 

Expenses    40 


Net  Profit  carried  to  Balance  Sheet $   460 

It  may  be  here  noted  that  as  a  mark  of  completion  the  equal 
totals  of  the  Balance  Sheet  are  always  underlined  with  a  double  rul- 
ing. Note  also  that  the  technically  complete  heading  for  the  Balance 
Sheet  includes  the  phrase  "as  of  February  i,  1920",  or  other  date,  and 
that  the  heading  of  the  Profit  and  Loss  Statement  always  shows  the 
period  covered,  as  "month  of  January,  1920",  or  "year  ended  Decem- 
ber 31,  1919". 


PROBLEMS— CHAPTER  IV. 

i.     Take  a  Trial  Balance  of  the  Ledger  from  problem  3,  Chapter 
III. 

2.  Turn  back  to  Chapter  II  for  the  several  illustrative  transac- 
tions again.  Analyze  each  transaction  there  into  terms  of  Debits  and 
Credits,  and  show  the  results  thus : 

Debit  the  Credit  the 

(1) account  with  $xx'x  account  with  $xxx 

(2) account  with  $xxx  account  with  $xxx 

etc. 

36 


3.  The  following  facts  are  given  about  P.  R.  Small's  business : 

On  Jan.  1,  Cash,  3000 ;  Debts  Payable,  1000 ;  Equipment,  1000 ;  Land  and  Build- 
ings, 5000;  Notes  Payable,  1000;  Debts  Receivable,  2000;  Notes  Re- 
ceivable, 1000. 

On  Feb.  1,  Notes  Receivable,  1500;  Debts  Receivable,  1000;  Notes  Payable, 
500;  Land  and  Buildings,  5000;  Equipment,  1500;  Debts  Payable, 
1500;  Cash,  4000. 

From  the  facts-  given  above,  after  studying  again  the  summary 
on  page  35,  calculate — 

(i)   Net  Worth,  January  i.     (2)   Net  Worth,  February  i.     (3) 
Profits  made  during  month  of  January. 

4.  From  the  following  Trial  Balance',  prepare  the  Balance  Sheet 
and  the  Statement  of  Profit  and  Loss. 


TRIAL  BALANCE 
K.   D.   Clark— Dec.  31,   19.. 

Sales    $ 

Notes    Receivable 1,200 

Notes    Payable 

John  McCrae,  Capital 

Furniture  and  Fixtures 700 

Debts    Receivable 4,400 

Cash  4,200 

Expense   1,800 

Debts   Payable 

Purchases    18,000 

Delivery   Equipment. 2,800 

Hand  and  Buildings 7,000 

Repairs    200 


$40,300 


$26,000 

900 

12,000 


1,400 


$40,300 


5.     Prepare  statements  from  exercises  in  the  text  book  to  be  in- 
dicated by  the  teacher. 


37 


V. 
THE  JOURNAL 

Personal  Accounts.  In  previous  discussions  mention  has  been 
made  of  Debts  Receivable  and  Debts  Payable.  We  are  now  to  ob- 
serve that  these  two  accounts  do  not  provide  a  sufficiently  detailed 
record  of  debts.  The  Proprietor  needs  to  know  not  only  the  total 
owing  to  him  and  by  him,  but  the  amount  due  from  each  individual 
customer  and  due  to  each  individual  creditor  as  well.  Consequently, 
accounting  must  provide  the  necessary  records. 

Instead  of  one  account  for  Debts  owing  to  us,  a  considerable 
space  in  the  Ledger  is  usually  set  aside  and  accounts  opened  therein 
for  every  customer  who  buys  on  credit.  Another  portion  of  the  Led- 
ger will  be  given  over  to  the  separate  accounts  of  the  people  we  owe. 
These  two  sections  of  the  Ledger,  then,  contain  the  accounts  of  debts 
receivable  by  us  and  the  accounts  of  debts  payable  by  us.  In  other 
words,  the  Ledger  contains  a  group  of  Accounts  Receivable  and  a 
group  of  Accounts  Payable. 

All  we  have  learned  in  the  past  about  a  Debt  Receivable  account 
applies  with  equal  force  to  each  separate  individual's  Account  Receiv- 
able. Whenever  an  account  is  opened  for  a  customer,  that  account  is 
an  Account  Receivable ;  it  is,  therefore,  an  Asset,  and  as  such  it  will 
have  a  debit  balance,  and  it  will  be  debited  for  increasing  transactions 
and  credited  for  decreasing  transactions. 

In  a  similar  way  we  can  describe  Accounts  Payable.  Whenever 
a  purchase  is  m^de  on  credit  a  debt  is  incurred;  in  order  properly  to 
record  it,  there  should  be  an  Acount  Payable  opened  with  the  indi- 
vidual creditor  and  headed  with  his  name.  Such  an  account  will  rep- 
resent a  Liability,  and  as  such  will  show  a  credit  balance,  and  will  re- 
ceive increasing  transactions  on  the  credit  side  and  decreasing  transac- 
tions on  the  debit  side. 

The  method  of  reasoning  out  transactions  is  in  no  way  changed 
by  the  introduction  of  personal  accounts  or  the  new  titles  "Accounts 
Receivable"  and  "Acounts  Payable".  In  analyzing  a  transaction  we 
still  ask  ourselves :  Which  two  accounts  are  increased  or  decreased  ? 
If  we  see  that  a  debt  is  contracted  or  discharged,  we  must  determine 

38 


whether  it  is  Receivable  or  Payable.  Then  we  can  determine  whether 
the  person's  account  is  to  be  debited  or  credited,  for  we  know  the  plus 
and  minus  arrangement  of  all  accounts,  including  personal  Accounts 
Receivable  and  Accounts  Payable. 

A  Book  of  Original  Entry.  Up  to  this  point  most  of  the  discus- 
sion has  had  to  do  with  statements  and  accounts  We  have  seen  the 
statements  expanded  into  a  book  (Ledger)  in  order  to  permit  the 
many  changes  to  the  items  to  be  easily  and  systematically  recorded, 
and  we  have  studied  the  classification  of  accounts,  together  with  the 
characteristics  of  each  class.  As  a  result,  we  are  able  to  analyze 
almost  any  transaction  and  determine  what  accounts  are  involved, 
whether  they  are  increased  or  decreased,  whether  debited  or  credited. 
We  have  heretofore  made  the  entries  direct  to  the  proper  accounts  in 
the  Ledger,  in  recording  the  results  of  our  analysis  of  transactions. 
This  has  been  done,  not  because  it  is  the  method  of  practical  business, 
but  in  order  to  confine  our  attentions  to  one  important  thing  at  a  time. 

In  actual  business,  no  entries  are  made  directly  into  the  Ledger 
accounts ;  there  is  always  a  preliminary  record  standing  between  the 
Transaction  and  the  Ledger ;  no  transaction  can  reach  the  Ledger  ex- 
cept through  this  "Book  of  Original  Entry".  There  are  two  reasons 
why  this  practice  has  grown  up  in  business.  The  first  is  the  need  for 
a  record  of  transactions  in  date  order,  which  can  be  made  as  they 
occur.  It  is  dangerous  to  wait  to  make  a  record  of  facts;  one  may 
forget  to  make  any  record  at  all,  or  may  omit  or  change  some  impor- 
tant particular  It  is  well,  too,  to  have  a  chronological  (date-order) 
record,  so  that  the  events  of  a  particular  day  will  be  grouped  together 
for  future  reference. 

The  other  reason  lies  in  the  fact  that  experience  has  proved  the 
usefulness  of  having  both  aspects  (debit  and  credit)  of  transaction  re- 
corded together.  Direct  entry  to  Ledger  accounts  causes  the  debit  of 
a  given  transaction  to  be  widely  separated  from  the  corresponding 
credit,  which  is  entered  in  some  other  account.  No  one  can  refer  to 
the  records  and  understand  what  has  happened  if  only  one  side  of  the 
transaction  is  seen,  and  we  can  not  comprehend  the  full  meaning  of 
debit  and  credit  entries  unless  we  know  what  was  debited  at  the  same 
time  this  or  that  was  credited.  It  is  often  necessary  to  trace  the  entry 
from  the  Ledger  account  back  into  the  transaction,  and  some  record 
is  necessary  to  connect  the  two ;  some  record  showing  in  one  place 
both  the  debits  and  the  credits  for  the  given  occurrence.  The  first 

39 


Book  of  Original  Entry,  and  the  basis  of  all  others,  is  the  Journal. 
The  reasons  for  its  existence  have  been  examined,  and  we  are  now  to 
consider  the  arrangement  of  the  entries  therein. 

It  has  been  observed  that  the  Journal  is  the  connecting  link  be- 
tween the  transaction  and  the  Ledger;  consequently  there  will  be  a 
great  deal  of  transferring  of  figures  from  Journal  to  Ledger  (posting, 
it  is  called).  The  problem  of  getting  the  correct  entry  made  in  the 
Ledger  involves  (i)  posting  to  the  proper  account,  (2)  posting  to  the 
proper  side  in  that  account,  and  (3)  writing  the  true  figure,  and  no 
other.  If  the  Journal  Entry  is  to  be  well  constructed,  it  should  be 
designed  with  the  possibilities  of  error  in  mind,  and  so  arranged  as  to 
help  reduce  mistakes  to  a  minimum.  The  form  of  the  entry  is  as 
follows : 


John  Brown 


July  24— 


Cash | 

Paid  the  account  due  today  for  goods 
bought  July  8th 


$400.00 


$400.00 


Posting.  In  every  Journal  Entry  there  are  three  essential  parts, 
(i)  the  accounts  involved,  (2)  the  amounts  involved,  (3)  the  ex- 
planation. In  addition  to  this,  there  usually  is  a  date  in  the  middle 
of  the  line  above  the  entry. 

The  account  to  be  debited  is  always  named  first,  and  is  written 
close  to  the  left  margin;  the  account  to  be  credited  is  always  named 
second,  and  is  indented  a  little  to  the  right.  This  arrangement  has 
the  effect  of  marking  out  the  debit  from  the  credit  to  even  the  most 
hurried  glance.  The  amount  to  be  debited  is  to  be  written  on  the  same 
line  as  the  account  name,  and  in  the  first  column ;  the  amount  to  be 
credited,  in  the  second  column.  Here  is  another  obvious  sign  of 
which  item  is  the  debit  and  which  the  credit.  .  Later,  we  shall  find  en- 
tries containing,  say,  one  debit  and  two  credits;  the  figures  might  be 
posted  to  the  wrong  side  of  the  account  unless  we  fix  in  mind  the 
principle  that  amounts  in  the  first  column  of  the  Journal  are  posted 
to  the  debit  side  of  the  accounts  and  amounts  in  the  second  to  the 
credit  side.  The  whole  idea  of  the  form  of  the  Journal  Entry  is  to 
make  posting  easier  and  more  accurate  by  directing  the  eye  irre- 
sistibly to  one  item  as  the  debit  and  to  the  other  as  the  credit. 

The  Journal  Entry  may  be  said  to  be  the  record  of  the  conclu- 
sion reached  in  analyzing  a  transaction.  The  accounts  to  be  debited 
and  credited  are  determined  by  analysis  and  reasoning;  the  result  of 

40 


the  thinking  is  made  note  of  by  constructing  the  Entry.  At  the  time 
of  posting,  it  is  not  necessary  to  reconsider  the  transaction;  judgment 
was  formed  before  the  Journal  Entry  was  made,  and  one  should  now 
transfer  to  the  Ledger  just  what  debits  and  credits  the  Journal  Entry 
states.  In  a  word,  be  sure  when  making  the  Journal  Entry  that  it 
shows  exactly  what  you  want  to  bring  into  the  Ledger;  then  posting 
becomes  an  easy  mechanical  routine.  No  Journal  Entry  should  be 
constructed  without  a  very  clear  idea  at  the  time  of  just  the  effect 
it  will  have  upon  the  accounts  when  posted. 

Errors.  Since  many  mistakes  occur  in  reading  and  writing  fig- 
ures, care  must  be  taken  to  make  figures  plain  and  unmistakable  in  the 
first  place,  and  then  to  read  them  with  mind  alert  when  they  are  to 
be  posted  and  rewritten.  Some  people  have  developed  a  habit  of 
forming  a  "picture"  of  the  figures  read,  and  then  writing  them  down 
as  they  looked  to  the  eye.  This  often  leads  to  mistakes.  The  proper 
way  is  to  read  the  figures  so  the  mental  impression  is  that  of  figures 
spoken  rather  than  seen;  then  while  writing  them  in  the  Ledger  the 
mental  image  should  again  be  that  of  spoken  figures.  Before  leaving 
the  particular  entry,  it  should  be  checked  back  by  glancing  at  the 
original  amount  again.  The  mental  point  of  view  can  easily  be 
changed  now  and  the  amounts  compared  as  purely  visual  images.  The 
same  principle  of  altering  the  mental  sequence  is  followed  in  checking 
addition  for  errors.  If  the  habitual  practice  is  to  add  the  column 
downward,  reverse  and  add  upward  when  checking.  The  habit  should 
also  be  developed  of  always  writing  the  Ledger  page  opposite  the 
posted  item  in  the  Journal  IMMEDIATELY  upon  posting.  Any  en- 
tries, then,  without  the  posting  page  suggest  an  error  because  of  an 
omitted  posting. 


41 


VI. 
SPECIAL  BOOKS  OF  ORIGINAL  ENTRY 

All  transactions  can  be  Journalized  and  posted  from  the  Journal, 
but  it  should  be  observed,  the  physical  limitation  of  a  single  Book  of 
Original  Entry  would  seriously  handicap  the  larger  business  of  today. 
There  are  too  many  transactions  to  be  contained  in  one  Journal ;  there 
are  many  more  entries  to  make  than  one  man  could  possibly  take  care 
of  alone.  Modern  business  has  been  forced  to  abandon  the  practice 
of  entering  every  transaction  through  the  Journal.  The  development 
which  has  taken  place  has  been  in  the  direction  of  subdividing  the 
general  purpose  Journal  into  several  special  purpose  Journals. 

Specialized  Journals.  If  the  problems  should  be  presented  of 
choosing  those  entries  which  should  hereafter  be  written  in  a  separate 
book,  one  would  naturally  seek  first  to  eliminate  from  the  Journal 
those  most  frequently  repeated.  No  doubt  Sales  entries  and  Pur- 
chase entries  would  first  attract  attention  by  their  number. 

Should  the  plan  be  adopted,  a  separate  Sales  Journal  to  receive 
only  entries  for  Sales  on  account  would  perhaps  provide  work  for  one 
man;  another  book,  a  Purchases  Journal  to  receive  entries  only  for 
Purchases  on  credit,  would  occupy  a  second;  a  third  might  have 
charge  of  the  general  Journal  for  all  other  entries.  Thus  at  least 
three  times  as  much  accounting  work  could  be  done  as  would  be  pos- 
sible with  only  one  Journal  and  one  bookkeeper. 

No  doubt  the  next  class  of  entries  found  numerous  enough  to 
warrant  a  separate  Journal  would  be  Cash  Receipts.  These  put  in 
charge  of  another  clerk  would  mean  further  subdivision  of  labor  and 
more  work  done.  The  process  of  subdivision  would  likely  be  carried 
a  step  further  and  the  Cash  Payments  set  up  in  a  separate  Journal. 
Quite  possibly  this  record  would  be  in  charge  of  the  same  person  hav- 
ing the  Cash  Receipts  to  care  for;  handling  all  the  cash — receipts  and 
payments — he  would  be  called  the  Cashier. 

The  ordinary  special  Journals,  then,  may  be: 

1 — Purchases  Journal — containing — 
Debits  to  Purchases  Account, 
Credits  to  various  Creditors'  accounts. 

42 


2 — Sales  Journal — containing — 

Debits  to   various   Customers'  accounts. 

Credits  to   Sales  Account. 
3 — Cash    Received   Journal — containing — 

Debits  to  Cash  Account, 

Credits  to  various  accounts. 
4 — Cash    Paid   Journal — containing — 

Debits  to  various  accounts, 

Credits  to  Cash  Account. 

The  subdivision  of  the  Journal,  it  should  be  noted,  does  not  alter 
in  any  way  the  analysis  of  transactions  and  their  expression  in  terms 
of  Debit  and  Credit.  The  Ledger  accounts  are  altogether  unchanged ; 
only  the  posting  is  changed,  and  that  simply  to  the  extent  of  there 
being  several  sources  of  posting  instead  of  one. 

Total  Posting.  The  subdivision  of  the  single  Journal  as  above 
described  is  more  expressive  of  the  idea  underlaying  Special  Books 
of  Original  Entry  than  it  is  of  the  form  Sales  Books,  Cash  Books,  etc. 
take  in  actual  practice.  Although  all  Books  of  Original  Entry,  what- 
ever their  form,  continue  to  express  both  Debits  and  Credits,  it  is 
not  necessary  in  modern  practice  carefully  to  name  both  accounts  in 
order  to  do  so.  A  moment's  consideration  of  the  Special  Journals 
will  make  this  plain. 

In  the  Sales  Journal,  every  credit  entry  will  be  a  credit  to  Sales 
Account.  What  would  be  simpler  than  to  find  the  total  of  all  the 
entries  for  a  month,  and  post  that  one  sum  to  the  credit  of  Sales 
Account  instead  of  positing  twenty  or  forty  (or  two  hundred)  sepa- 
rate amounts?  Estimate  the  lessened  chance  of  mistakes  and  the 
saving  of  time  in  posting  one  figure  compared  with  forty.  Consider 
the  saving  of  time  in  writing  only  half  as  much  in  recording  an  entry. 

In  a  Sales  Journal,  several  entries  would  take  this  form : 

SALES  JOURNAL 

John  Jones..  $600 

Sales $600 

H.  K.  Potts.. 700 

Sales 700 

P.  D.  Downs 400 

Sales 400 

Etc.,   etc. — 

But  since  every  Credit  is  to  be  to  Sales  Account  finally,  and  since 
the  Debit  figures  are  the  same  amount  as  the  Credit  in  each  entry,  we 
accomplish  as  much  with  modern  Sales  Book  as  we  could  with  a  Sales 

43 


Journal,  by  writing  the  debit  portion  only  and  obtaining  the  credit  by 
adding  the  debits.     Thus  the  Sales  Book  would  be  as  follows : 

SALES  BOOK 

John  Jones $    600 

H.  K.   Potts 700 

P.  D.  Downs 400 


Total  Sales    (Cr.) $1,700 

In  posting  the  above,  the  three  items  would  go  simply  to  the 
debit  of  the  Personal  accounts  named  one  by  one,  and  at  the  end  of 
the  month  these  three  Debits  would  be  equalized  in  the  Ledger  by  the 
corresponding  Credit  of  $1,700.  Thus  the  Trial  Balance  would  not 
be  disturbed  by  any  inequality  of  Debits  and  Credits. 

What  has  been  said  in  detail  about  the  Sales  Book  could  be  said 
about  each  of  the  others;  the  plan  that  would  secure  economy  of  time 
and  increased  accuracy  in  one  would  apply  equally  well  to  the  others. 
So  we  would  find  the  Purchase  Book  producing  a  total  to  be  debited 
to  Purchases  Account;  Cash  Received  a  total  to  be  debited  to  Cash 
Account;  Cash  Paid,  a  total  to  be  credited  to  Cash  Account. 

With  a  number  of  Books  of  Original  Entry  in  use  it  is  necessary 
to  decide  which  book  should  receive  the  given  entry  you  are  working 
upon.  The  way  to  decide  that  is  to  reason  out  the  debits  and  credits 
for  the  transaction  in  exactly  the  same  way  as  if  you  were  going  to 
make  a  regular  Journal  entry  for  it.  With  the  Debits  and  Credits 
that  you  want  to  have  posted  to  the  Ledger  thus  in  mind  you  will  de- 
cide which  book  to  use  by  remembering  what  Debits  and  Credits  ac- 
counting practice  says  shall  be  posted  from  those  books,  and  by  se- 
lecting the  one  which  usually  contains  the  Debits  and  Credits  of  your 
transaction. 

The  close  relation  of  the  Cash  Received  Book  and  Cash  Paid 
Book,  and  the  fact  that  both  have  to  be  used  in  rinding  the  balance  of 
Cash  on  hand  at  any  time,  leads  to  the  practice  of  having  them  bound 
together,  or,  what  amounts  to  the  same  thing,  using  only  one  volume 
by  writing  Cash  Received  entries  on  the  left-hand  page  and  Cash 
Paid  entries  on  the  right-hand  page.  This  is  a  very  convenient  ar- 
rangement, and  does  not  disturb  in  the  least  the  postings  as  already 
described ;  the  same  accounts  are  Debited  and  Credited  in  detail  and 
total  from  the  one  volume  Cash  Book,  as  from  two  separate  Cash 
Books. 

44 


Later  on  we  shall  see  the  form  of  the  Cash  Book  modified  by  the 
introduction  of  a  number  of  extra  money  columns  for  the  further 
segregation  of  like  entries.  At  that  time  it  will  be  pointed  out  in 
more  detail  that  such  an  arrangement  permits  the  accumulation  of 
totals  so  that  the  quantity  of  posting  is  again  reduced  just  as  it  is 
where  Special  Books  of  Original  Entry  replace  a  single  Journal. 

PROBLEMS— CHAPTER  VI. 

1.  Use  such  exercises  in  the  2Oth  Century  Text  as  the  teacher 
may  indicate,  and  enter  the  transactions  in  four  special  Journals.    The 
entries  are  to  contain  Debits  and  Credits  just  as  every  Journal  entry 
does,  but  only  transactions  for  Sales  on  account  are  to  be  entered  in 
the  Sales  Journal,  only  Purchases  of  merchandise  on  account  in  the 
Purchase  Journal,  etc. 

2.  After  the  teacher  has  approved  problem  i  above,  make  four 
new  Journals  for  the  same  exercise,  but  in  entering  the  transactions 
this  time  omit  that  part  of  each  one  which  was  constantly  repeated 
in  the  entries  made  in  problem  i. 

Be  prepared  to  explain  how  the  posting  from  these  new  Journals 
will  bring  exactly  the  same  total  Debits  and  Credits  to  the  Ledger  as 
would  the  posting  from  the  Journals  in  problem  i. 


VII. 

DIRECT  CLOSING 

Purpose  of  Closing.  In  Chapter  IV  it  was  pointed  out  that  the 
profit  earned  by  a  business  belonged  to  the  Proprietor.  It  was  also 
shown  how  the  Net  Profit  on  the  Profit  and  Loss  Statement  must  be 
brought  into  the  Balance  Sheet  as  an  addition  to  the  Proprietor's 
previous  investment  in  order  to  cause  the  Balance  Sheet  to  exhibit 
the  true  state  of  affairs  at  that  particular  time. 

If  the  real  fact  is  that  the  Proprietor's  interest  in  the  business 
on  February  i  is  more  than  the  Ledger  account  for  Capital  Invest- 
ment shows,  it  must  follow  that  the  account  should  be  adjusted  so  it, 
as  well  as  the  Balance  Sheet,  may  state  the  whole  truth  about  Capital 
Investment.  This  can  only  mean  that  the  Proprietor's  Account  in 
the  Ledger  must  be  increased  by  the  amount  of  the  profit  made. 

Since  the  profit  is  determined  by  the  amount  of  the  Sales,  Pur- 
chases and  Expenses,  these  are  the  accounts  which  must  be  brought 
into  relationship  with  the  Proprietor's  Account  in  order  to  increase 
it  by  the  amount  of  Net  Profit. 

Direct  Closing.  In  order  to  see  these  nominal  accounts  trans- 
ferred to  the  Capital  Account,  it  is  necessary  to  look  at  the  Ledger  as 
it  now  stands,  and  then  to  trace  step  by  step  the  changes  produced  by 
the  desire  to  assemble  these  several  accounts  in  one  place.  The  ac- 
counts we  are  interested  in  just  now  are  as  follows: 


Purchases 


plus 
$700 


plus 
$40 


minus 


Expense 


minus 


Sales 


minus 


plus 
$1,200 


H.   B.   K.    Capital   Invested 


minus 


plus 
$5,900 


(The  student  should  take  a  copy  of  these  accounts  on  scratch  paper  and 
make  the  changes  therein  one  by  one  as  they  are  discussed  in  the  text.) 

46 


METHOD  I. 

1.  Bring  the  $700  Purchases  to  the  minus  (Debit)  side  of  Cap- 
ital Account  and  it  appears  that  Capital  is  temporarily  reduced.    With 
the  $700  now  in  Capital  Account  the  Purchase  Account  is  no  longer 
useful ;  it  should  be  brought  to  a  "zero"  condition  by  an  entry  of  $700 
on  the  minus  side.     Here,  then,  is  expressed  a  decrease  to  Purchases 
Account  and  a  decrease  to  Capital;  the  $700  value  has  been  removed 
or  subtracted  from  the  former  account  and  placed  in  the  latter.  (Note 
the  peculiar  way  accounting  expresses  a  subtraction  within  accounts 
through  effecting  a  cancellation  of  an  item  by  an  equal  entry  on  the 
apposite  side  of  the  same  account.) 

2.  Bring  the  $40  from  Expense  Account  to  the  Capital  Account 
in  the  same  manner.     This  second  step  has  the  effect  of  transferring 
this  other  Recoverable  Outlay  also  to  the  Capital  Account.     Now  the 
Proprietor's   Capital   seems   materially   redured  by   these   entries,  but 
we  know  the  outlays  were  only  temporarily  advanced,  and  that  the 
proprietor  got  his  money  back  again  almost  ait  once. 

During  the  month,  as  Sales  were  made  and  part  of  the  costs  and 
expenses  recovered,  the  amounts  received  from  Sales  were  assembled 
in  the  Sales  Account.  Now  at  the  end  of  the  period  it  is  desired  to 
bring  these  Recovered  amounts  into  close  comparison  with  the 
amounts  advanced  to  see  what  the  net  effect  upon  the  Proprietor's  in- 
terest in  the  business  has  been. 

3.  Bring  the  $1,200  Sales  into  the  Capital  Account  on  the  in- 
crease side,  thus  setting  it  up  in  opposition  to  the  costs  already  on  the 
decrease  side.     Show  the  $1,200  eliminated  from  the  temporary  Sales 
Account  by  placing  another  $1,200  on  the  decrease  side. 

4.  Whenever  the  two  opposing  sides  of  an  account  are  equal  (in 
balance,  as  we  say),  indicate  the  fact  by  ruling  a  double  horizontal 
line  across  the  account  close  up  under  the  figures.     This  has  the  ef- 
fect of  shutting  off  the   figures   above  the  line   so  they  will   not  be 
added  in  with  any  new  figures  for  succeeding  periods  which  may  be 
posted  to  the  account  later. 

5.  As  a  last  step,  bring  the  Capital  Account  to  a  balance,  rule 
it  up,  and  bring  the  balance  forward  into  the  new  period  as  in  the 
illustration  on  the  next  page. 

47       '* 


The  Ledger  now  stands  as  follows: 
Purchases 


Sales 


plus 
$700 


minus 
$700 


minus 
$1,200 


plus 
$1,200 


Expenses 


Capital 


plus 
$40 


minus 
$40 


minus 

Purchases,     $700 
Expenses,          40 
Balance,  new 
Capital      6,360 

$7,100 


plus 

Original      $5,900 
Sales  1,200 


$7,100 

Present 
Invest- 
ment ...$6,360 


METHOD  II. 


Another  method  of  closing  these  nominal  accounts  and  transfer- 
ing  their  balances  into  the  Capital  Account  is  to  proceed  through  an 
intermediate  summary  account.  For,  it  will  be  observed,  the  above 
Capital  Account  does  not  clearly  show  what  the  net  increase  to  Capi- 
tal is  (i.  e.,  the  amount  of  the  Net  Profit).  It  is  desirable  to  show 
this  in  the  Ledger  as  one  amount,  and  it  is  also  desirable  to  avoid 
bringing  many  accounts  (as  in  a  large  business)  directly  into  the 
Capital  Account.  For  these  reasons  a  Profit  and  Loss  Account  is  in- 
troduced to  provide  a  convenient  place  of  summarizing  the  nominal 
accounts  and  calculating  the  net  profit  to  be  carried  as  one  figure  to 
the  Capital  Account. 

1.  On  a  separate  sheet  of  paper  copy  the  accounts  as  they  stand 
on  page  46. 

2.  Open  a  new  account  headed  "Profit  and  Loss". 

3.  Transfer  the  $700  from  Purchases  Account  to  the  Profit  and 
Loss  Account.      (Note  this  principle:  the  amount  transferred   from 
any  account  whatever  must  appear  in  the  new  account  on  the  same 
side,  Debit  or  Credit,   as  the  original  amount  stood  in  the  original 
account.)     Profit   and   Loss   is   debited   $700;    Purchases   is   credited 
$700.    The  original  debit  in  Purchases  Account  (cancelled  by  the  new, 
opposing  entry)   is  now  transferred  to  be  a  debit  in  the  Profit  and 
Loss  Account — once  a  debit,  always  a  debit. 


48 


4.  Transfer  in  like  manner  the  credit  from  Sales  Account  into 
Profit  and  Loss  Account. 

At  this  point  we  calculate  -the  balance  of  the  Profit  and  Loss 
Account  before  making  further  entries,  in  order  to  show  the  amount 
of  the  Gross  Profit. 

5.  Calculate  the   Gross    Profit,   enter   it   as    a   balance   on   the 
smaller  side,  rule  the  account,  and  bring  the  balance  down  below  the 
ruling. 

6.  Transfer  the  debit  from  Expense  account  by  debiting  Profit 
and  Loss  and  crediting  Expense.    Rule  off  the  accounts  that  now  are 
in  balance. 

The  nominal  accounts  are  now  closed  off  and  ruled  since  their 
values  are  summarized  in  the  Profit  and  Loss  Account.  The  credit 
side  (Gross  Profit)  is  seen  to  be  larger  than  the  debit  (Expense),  and 
the  conclusion  is  that  a  net  profit  has  been  made.  The  excess  of 
credits  over  debits  in  this  account  (i.  e.,  the  credit  balance)  is  the 
amount  of  net  profit  to  be  added  to  the  Capital  Account. 

7.  Transfer  the  Balance  of  the  Profit  and  Loss  Account  to  the 
Capital  Account.     Since  the  Profit  and  Loss  credits  are  more  than 
the  debits,  it  will  be  necessary  to  introduce  another  debit  to  eliminate 
the  balance  and  close  off  the  Profit  and  Loss  Account.     Since  Net 
Profit  naturally  increases  the  Capital  Account,  there  must  be  a  credit 
to  that  account  of  the  same  amount  as  was  debited  to  Profit  and 
Loss  just  now. 

8.  Calculate  the  Present  Investment   (Original  Investment  plus 
Net  Profit)  ;  close  the  Capital  Account  and  bring  the  Present  Invest- 
ment forward  as  before. 


Profit  and  Loss 


Capital 


Purchases     $700 
Balance, 

Gross 

Proifit        .   500 


$1,200 

Expenses,      $  40 

Balance, 
Net  Profit, 
transferred 
to  Capital,   460 

$500 


Sales,          $1,200 

$1,200 
Gross  Profit  $500 

$500 


Balance, 
Present 
Invest- 
ment 
carried 
down  ...$6,360 

$6,360 


Original 
Invest- 
ment ...$5,900 

Net  Profit 
from  P.  & 
L.  account  460 

$6,360 

Present 
Invest- 
ment ...$6,360 


49 


Inventories.  In  the  discussions  up  to  this  point  it  has  been  as- 
sumed for  the  sake  of  simplicity  that  all  of  the  merchandise  pur- 
chased was  sold  in  the  same  period.  This,  of  course,  does  not  often 
happen  in  actual  business,  for  some  of  last  month's  purchases  have 
to  be  carried  over  into  the  next  month  or  longer,  and  are  sold  in  some 
subsequent  period.  The  fact  that  some  goods  have  to  be  carried  over 
unsold  makes  a  great  deal  of  difference  in  the  profits  of  a  given  pe- 
riod. No  one  can  claim  a  profit  until  the  ownership  of  the  goods 
passes  to  another,  so  the  method  of  calculating  profits  must  be  re- 
vised. 

Where  all  goods  are  sold  in  the  same  period  as  they  are  bought, 
we  may  say  that  Sales  less  Purchases  equals  Gross  Profits.  But  if 
some  of  the  Purchases  are  unsold,  we  must  say  Sales  less  Cost  of 
Goods  Sold  equals  Gross  Profit  (i.  e.,  that  profit  before  deducting 
Expenses).  Therefore,  before  finding  Gross  Profit  it  is  necessary  to 
make  another  calculation — one  to  find  the  Cost  of  Goods  Sold. 

Suppose  in  a  given  period  we  bought  $8,000  worth  of  goods,  and 
at  the  end  of  the  period  found  by  actual  count  (i.  e.,  by  taking  inven- 
tory) that  $2,000  of  the  purchases  were  still  on  hand.  The  conclu- 
sion would  naturally  follow  that  $6,000  ($8,000  less  $2,000)  was  the 
purchase  cost  of  the  goods  sold.  Then,  if  in  the  same  period  the 
sales  amounted  to  $10,000,  the  Gross  Profit  would  be  $4,000  ($10,000 
less  $6,000). 

If  an  Inventory  of  unsold  goods  exists  at  the  time  of  summariz- 
ing and  closing  the  nominal  accounts,  it  must  be  considered  as  the 
very  first  step  of  the  process.  .Before  transferring  the  balance  of 
Purchases  Account  to  the  Profit  and  Loss  Account,  the  Inventory 
must  be  eliminated  from  the  former  so  that  the  amount  to  be  trans- 
ferred will  be  the  cost  of  goods  sold.  If  the  Inventory  be  taken  out 
of  purchases  Account,  it  must  be  set  up  somewhere  else,  for  one  can 
not  bodily  abstract  a  portion  of  the  amount  in  an  account. 

Since  the  Inventory  is  an  amount  of  goods  on  hand,  it  takes  on 
for  the  moment  the  characteristic  of  an  asset.  It  will  appear  in  the 
Balance  Sheet  as  such,  and  should  stand  in  the  Ledger  in  a  separate 
account.  The  procedure  under  these  conditions  will  be  as  follows : 

i.  Transfer  the  value  of  the  Inventory  (taken  at  cost  prices) 
from  the  Purchases  Account  to  an  "Inventory  Account".  This 
necessitates  a  credit  (minus)  to  Purchases  and  a  debit  (as  a  plus  to  an 
asset)  to  Inventory  Account.  The  balance  then  remaining  in  Pur- 

50 


chases  represents  the  cost  of  that  portion  of  the  purchases  which 
was  sold. 

2,  Transfer  this  balance  of  Purchases  Account  (i.  e.,  cost  of 
goods  sold)  to  the  debit  side  of  Profit  and  Loss. 

The  other  steps  in  the  closing  process  are  identical  with  those  al- 
ready outlined. 

Old  and  New  Inventories.  If  we  are  working  in  any  but  the 
first  month  of  a  firm's  existence,  we  will  see  that  there  is  not  only  an 
Inventory  of  goods  unsold  at  the  end  of  that  particular  period,  but 
that  there  is  also  an  Inventory  of  goods  on  hand  at  the  beginning  of 
the  month.  There  is  an  old  and  a  new  Inventory;  next  month  the 
present  new  Inventory  becomes  the  old  one. 

In  order  to  calculate  the  Gross  Profit,  it  is  still  necessary  first  to 
find  the  costs  of  goods  sold  in  the  given  period;  usually  this  calcula- 
tion involves  two  Inventories.  The  goods  we  dispose  of  this  month 
may  have  been  bought  this  month  or  last  month;  they  may  have  been 
sold  from  the  old  Inventory  or  from  current  purchases. 

Suppose  we  sold  all  we  had;  then  the  cost  of  goods  sold  would 
be  the  old  Inventory  plus  the  purchase  of  this  current  month,  and 
that  figure  deducted  from  the  Sales  would  give  the  Gross  Profit  But 
that  condition  prevails  only  in  the  last  month  of  a  firm's  existence ;  the 
ordinary  month  will  have  a  new  Inventory  at  the  end  to  be  sub- 
tracted. Using. some  hypothetical  figures,  the  calculation  of  an  ordi- 
nary month's  gross  profit  would  be  as  follows : 

Sales  during  the  month $20,000 

Old  Inventory  at  beginning  of  month $  8,000 

Add,  Purchases  during  the  month 14,000 


$22,000 

Deduct  New  Inventory  at  end  of  month 9,000 

Cost  of  Goods  Sold 13,000 

Gross   Profit $  7,000 

(Let  it  be  noted  that  this  shows  the  arrangement  of  a  section  of 
the  Profit  and  Loss  Statements  as  it  appears  when  there  are 
some  inventories  to  be  included.) 

We  have  to  note  how  these  additions  and  subtractions  are  se- 
cured in  the  Ledger  and  how  the  adjustment  of  the  accounts  results 
in  the  calculation  of  the  Profit  directly  in  the  Ledger  accounts. 

The  student  should  copy  these  accounts'  as  before,  and  make  the 
adjustments  as  they  are  described.  The  accounts  as  they  stand  at 

51 


the  close  of  last  month    (after   following  instructions   on   page   50) 
would  be  as  follows : 


Inventory 


Purchases 


from  Pur. 
a/c   $8,000 


Bought,     $15,000 


to  inv.  a/c  $8,000 
toP/La/c   7,000 


Sales 


Profit  and  Loss 


toP/L 

a/c   ....$17,000 


Sold    ....$17,000 


Cost  $  7,000 

to  Cap.  a/c  10,000 


Sales  ....$17,000 


All  of  the  accounts  we  need  to  consider  here  will  be  seen  to  be 
blank  below  the  ruling,  except  Inventory  account,  for,  being  ruled  at 
the  end  of  last  month,  they  are,  to  all  intents  and  purposes,  void  of 
figures  now. 

Assume  the  Purchases  of  this  current  month  to  have  been  $14,000 
and  the  Sales  $20,000.  Enter  the  amounts  in  the  accounts  as  if  they 
had  been  posted  there.  We  are  now  ready  to  close. 

1.  Transfer  the  old  Inventory   ($8,000)   back  to  the  Purchases 
Account.     It  will  now  appear  canceled  out  of  the  Inventory  Account 
and  set  up  as  a  debit  to  the  Purchases  Account  to  be  added  in  with 
the  goods  purchased  during  this  current  month.     The  debit  side  of 
the  Purchases  Account  now  shows  the  total  cost  of  all  goods  offered 
for  sale  regardless  of  when  they  were  purchased. 

2.  The  new  Inventory  is  found  by  an  actual  count  of  the  arti- 
cles on  the  shelves  to  be  $9,000.     Transfer  this  Inventory  from  the 
Purchases  Account  to  the  Inventory  Account  by  crediting  Purchases 
and  debiting  Inventory.    The  balance  remaining  in  the  Purchases  Ac- 
count now  shows  the  true  cost  of  goods  sold.     (Compare  with  the 
section  of  the  Profit  and  Loss  Statement  on  page  51). 

3.  Transfer  this  cost  of  goods  sold  to  the  Profit  and  Loss  Ac- 
count; transfer  Sales  and  Expenses,  and  proceed  from  this  point  as 
previously  instructed. 


52 


The  accounts  as  readjusted  in  closing  as  above  outlined  for  two 
Inventories  are  as  follows.  The  values  for  the  second  period  are  in 
italics : 


Inventory 


Purchases 


From  Pur-                  Return  to 
chases  a/c  $8,000       Purchas- 
es a/c 

From  Pur- 
chases a/c     9,000 

Bought      $15,000 
$8,000 

From  In- 
ventory 
a/c            $  8,000 
Bought       14,000 

To  Inven- 
tory a/c    $  8,000 
ToP&L 
a/c                7,000 

To  Inven- 
tory a/c     $  9,000 
ToP&L 
a/c              13,000 

Expense 

Sales 

Cost            $1,200       To  P  &  L                       To  P  &  L 
a/c              $1,200            a/c            $17,000 

Sold          $17,000 

To  P  &  L                      To  P  &  L 
Cost              1,800       a/c                1,800           a/c            $20,000 

Sold          $20,000 

f 

Profit  and  Loss 

From  Purchases  a/c 
Balance,  Gross  Profit 

$  7,000 
10,000 

From  Sales  a/c 

$17,000 

From   Expense  a/c 
Net  Profit,  to  Capital  a/c 

1,200 
8,800 

Gross  Profit  down                       10,000 

From  Purchases  a/c 
Balance,  Gross  Profit 

13,000 
7,000 

From  Sales  a/c 

20,000 

From  Expense  a/c 
Net  Profit,  to  Capital  a/c 

1,800 
5,200 

Gross  Profit  down                         7,000 

Capital 

Balance  forward 

$33,800 

Original  investment                   $25,000 
From  P  &  L  a/c                           8,800 

33,800 

33,800 

Balance   forward 

39,000 

Present  Capital                            33,800 
From  P  &  L  a/c                         5,200 

39,000 

39,000 

Present  Investment                      39,000 

53 


„  PROBLEMS— CHAPTER  VII. 

i.  Below  are  tabulated  the  essential  facts  about  the  nominal 
accounts  of  a  business  of  four  successive  periods.  First,  on  Ledger 
paper  open  the  necessary  blank  accounts;  then,  second,  one  month  at 
a  time,  place  the  Purchases,  Sales  and  Expenses  values  in  the  ac- 
counts as  if  posting,  and  then,  third,  close  the  accounts  for  the  month. 
Proceed  in  like  manner  for  the  second  month,  then  the  third,  and 
then  the  fourth. 

What  is  the  present  capital  at  the  end  of  the  four  months,  if  the 
original  Investment  was  $10,000? 

Beginning      Closing         Month's         Month's       Month's 


Month 
Jan    

Invty. 
$5,000 

Invtv. 
$9,645 

Purchases 
$  8,296 

Sales 
$14,642 

Expense 
$   900 

Feb 

9645 

8471 

11  318 

12978 

1200 

Mar 

8471 

6272 

16^684 

16,491 

1687 

Aor.   . 

6.272 

7.448 

13,841 

18,296 

1.407 

54 


VIII. 
JOURNAL  CLOSING 

The  previous  discussion  of  closing  does  not  pretend  to  portray 
the  procedure  found  in  practice.  It  has  already  been  pointed  out 
that  no  entries  are  made  directly  in  the  Ledger  and  closing  entries 
are  no  exception.  But  it  should  be  remembered  that  Journal  Entries 
of  any  kind  express  debits  and  credits,  and  that  debits  and  credits 
can  be  determined  only  by  thinking  of  accounts.  Therefore,  no  mat- 
ter what  the  entry,  it  is  to  be  constructed  with  the  Ledger  accounts 
in  mind.  When  we  have  decided  what  change  has  occurred  to  the 
accounts  it  is  an  easy  matter  to  construct  a  Journal  Entry  to  record 
our  decision.  But  the  accounts  have  to  be  thought  out  first;  the  Jour- 
nal Entry  only  records  our  judgment. 

So  the  discussion  of  closing  the  nominal  accounts  directly  in  the 
Ledger  has  shown  the  way  the  steps  must  be  thought  out.  Now  to 
get  those  changes  made  in  the  accounts  according  to  the  very  strict 
accounting  practice,  they  must  be  entered  in  a  book  of  original  entry 
and  posted. 

The  form  of  ordinary  Journal  Entry  is  already  in  mind ;  we  have 
but  to  decide  the  debits  and  credits  for  each  step,  arrange  them  in 
the  customary  way  and  post.  Using  the  example  on  pages  52  and  53, 
the  several  steps  would  become  Journal  Entries  as  follows: 

1 — Purchases    $  8,000 

Inventory   $  8,000 

to  transfer  last  months'  inventory  to 
Purchases  Account. 

2— Inventory    9,000 

Purchases   9,000 

to  transfer  the  present  inventory  out  of 
Purchases  Acct.  into  an  account  of  its  own. 

3— Profit  and  Loss .   13,000 

Purchases    13,000 

to  transfer  the  cost  of  goods  sold  (bal- 
ance of  Purchases  Account)  to  the  Profit 
and  Loss  Account. 

4— Sales   20,000 

Profit  and  Loss 20,000 

to  transfer  the  balance  of  Sales  Account 
to  Profit  and  Loss. 

55 


5— Profit  and  Loss 900 

Expense   900 

to  transfer  Expense  into  Profit  and  Loss. 

6— Profit  and  Loss 6,100 

Capital  Investment 6,100 

to    transfer    the    net    profit     (balance    of 
Prolfit  and  Loss  Account)  to  Capital. 

It  must  be  clearly  understood  that  these  entries  should  not  all 
be  made  at  once.  We  can  not  make  entry  3,  for  example,  before  en- 
tries i  and  2  have  been  made  and  posted,  for  those  net  values  have 
to  be  used  in  calculating  the  $13,000  for  entry  3.  Hence  the  follow- 
ing suggestions: 

1.  Reason  out  the  debit  and  credit  you  want  brought  into  the 
accounts  as  the  first  step  in  the  series. 

2.  Make  a  Journal  Entry  for  them. 

3.  Post  this  first  entry  before  constructing  the  next. 

4.  Reason  out  the  next  step  of  summarizing  the  nominal   ac- 
counts, using,  when  necessary,  the  values  now  in  the  accounts  which 
were  changed  by  the  preceding  entry  or  entries. 

And  so  on,  step  by  step,  through  the  whole  series,  until  all  nom- 
inal accounts  are  closed  and  their  contents  summarized  in  the  Profit 
and  Loss  Account  and  it  closed  to  the  Capital  Account. 

Often  it  is  desirable  to  be  able  to  make  closing  Journal  entries 
with  only  a  Trial. Balance  before  you.  It  is  not  difficult  if  you  have 
the  accounts  involved  quite  clearly  in  mind  or  construct  memorandum 
accounts  on  scratch  paper  as  you  go  along. 


PROBLEMS— CHAPTER  VIII. 

1.  Construct  closing  Journal  Entries  for  the  problem  at  the  end 
of  Chapter  VII,  and  post  them  to  memorandum  Ledger  accounts  as 
you  go  along.     This  concurrent  posting  is  necessary  because  some  of 
the  values  to  be  used  in  the  closing  entries  are  the  balances  of  these 
accounts. 

2.  From  the  facts  given  in  the  Trial  Balances  which  the  teacher 
will  select  from  the  text  book,  make  the  Journal  Entries  necessary  to 
close  the  Ledgers   from  which  the  Trial  Balances  presumably  were 
taken. 


56 


IX. 
MONTHLY  ADJUSTMENTS 

It  is  one  of  the  outstanding  principles  of  accounting  that  profit 
is  earned  when  the  service  is  rendered  for  which  the  profit  is  a  pay- 
ment, rather  than  when  the  cash  is  received.  This  principle  arises  in 
our  understanding  of  profit  as  the  gain  coming  to  the  business  man  as 
his  compensation  for  the  service  he  performs  in  making  or  supplying 
the  goods. 

Deferred  Income.  When  we  sell  goods  on  account  for,  say, 
$800,  the  credit  to  Sales  represents  an  earning  of  this  period;  the 
debit  to  Accounts  Receivable  represents,  in  a  way,  a  "deferred  cash 
collection".  When  we  receive  money  for  a  sale  in  advance  of  the 
actual  transfer  of  tke  things  sold,  or  in  advance  of  actually  perform- 
ing all  of  the  services  agreed  upon,  then  we  debit  Cash  to  record  the 
increase  in  our  balance  on  hand  and  the  credit  we  place  in  a  Deferred 
Income  Account.  This  is  not  closed  like  a  Sales  Account  into  Profit 
and  Loss,  for  be  it  noted,  it  does  not  contain  Profits  (or  Earnings) 
of  this  month ;  we  have  not  earned  our  compensation  for  we  have  not 
yet  done  our  part.  We  must  see  in  the  Deferred  Income  Account 
something  of  a  Liability,  for  it  represents  an  obligation  to  perform  a 
service  which  we  are  bound  to  carry  out  because  of  having  already 
been  paid  for  it. 

As  an  example  of  Deferred  Income  we  can  refer  to  the  Mem- 
bers' dues  of  a  club  or  society.  Suppose  the  dues  are  $60  a  year; 
being  paid  at  one  time,  they  give  the  member  all  privileges  for  twelve 
months.  If  accurate  accounting  is  to  be  had  by  the  club  of  the  costs 
for  each  month,  and  the  income  available  each  month  to  defray  those 
costs,  provision  must  be  made  for  distributing  only  $5  of  the  $60  to 
the  Profit  and  Loss  Account  for  each  month. 

When  a  member  pays  in  advance,  Cash  is  debited  $60  and  De- 
ferred Income  (or  Dues  account)  is  credited.  As  each  month  comes 
to  an  end  1-12  of  the  $60  is  transferred  to  the  Profit  and  Loss  Ac- 

57 


count  to  offset  the  Expenses,  which  will  also  be  closed  into  the  same 
account.    The  entry  each  month  should  be: 

Dues  Account  (or  Deferred  Income  Acct.) $5 

Profit  and  Loss  Account $5 

to  transfer  1/12  of  the  year's  earnings  into  the  Profit 
and  Loss  Account  for  the  current  month. 

This  entry  would  accomplish  the  results  desired.  $5  would  be 
taken  from  the  Deferred  Income  Account  by  the  debit  (decreasing) 
entry  and  added  to  the  Profit  and  Loss  Account  by  the  credit  entry. 
There  would  remain  a  balance  of  $55  in  the  Deferred  Income  Ac- 
count to  evidence  the  Liabilities  for  service  to  members  still  to  be 
performed.  Other  examples  of  deferred  income  are  not  hard  to  find 
in  some  lines  of  business,  such  as  newspaper  and  magazine  publish- 
ing, for  example;  but  they  do  not  frequently  appear  in  the  ordinary 
mercantile  business. 

Deferred  Charges.  A  companion  principle  to  the  one  which 
opened  this  chapter  is  this:  An  expense  or  a  cost  is  incurred  in  the 
period  receiving  the  benefits  regardless  of  the  time  of  the  cash  pay- 
ment. When  we  acquire  merchandise  in  a  given  period  it  is  consid- 
ered in  that  period's  calculation  of  Profit  and  Loss  whether  it  has  been 
paid  for  yet  or  not;  the  same  can  be  said,  of  course,  about  expenses. 
If  electric  light  is  used,  its  value  is  recoverable  out  of  current  profits 
in  spite  of  the  fact  that  the  cash  is  not  paid  to  the  Light  Company 
until  later.  What  would  be  the  situation  if  we  had  paid  for  our  ex- 
penses in  advance — paid  for  a  year's  electric  current,  say? 

Clearly  we  would  have  a  valuable  right  outstanding  against  the 
Light  Company  which  they  would  have  to  discharge  month  by  month 
as  we  wanted  to  use  electricity— in  a  word,  we  have  here  something 
closely  akin  to  an  Asset,  though  not  one  in  truth.  What  we  do  have 
is  a  Deferred  Charge — an  expense  paid  in  advance. 

As  in  the  case  of  Deferred  Income,  period  by  period  the  proper 
portion  of  the  Deferred  Charge  is  transferred  to  some  Expense  ac- 
count (and  thence  to  Profit  and  Loss),  while  the  balance  remaining 
is  carried  forward  in  the  account  (and  in  the  Balance  Sheet)  to  the 
next  period,  there  to  be  further  reduced,  and  so  on  to  the  end. 

One  of  the  most  commonly  met  examples  of  Deferred  Charges 
is  supplies,  like  paper,  advertising  matter,  ink,  etc.,  which  are  often 
bought  in  larger  quantities  than  the  needs  of  one  period  would  re- 
quire. Another  common  Deferred  Charge  is  unexpired  insurance. 

58 


There  are  two  ways  of  dealing  in  the  accounts  with  facts  of  this 
kind,  either  of  which  is  good  if  consistently  followed.  Take  Insurance 
as  an  example.  We  may  have  the  Insurance  Account  classed  as  an 
Expense.  In  this  case  the  balance  would  be  one  to  be  transferred 
to  the  Profit  and  Loss  Account  at  the  end  of  the  month.  Should 
there  be  any  unexpired  insurance  in  this  account  it  will  have  to  be 
removed  before  the  account  is  closed.  The  entries  in  their  sequence 
are — 

(1) 

Insurance  $  1,200 

Cash $  1,200 

Insurance  premium  paid  for  year  in  advance 

(2) 

Deferred   Charges 1,100 

Insurance    1,100 

to  transfer  11/12  of  the  Insurance  Account  to 
a  Deferred  Charges  Account  at  the  end  of 
the  first  month. 

(3) 

General  Administrative   Expense 100 

Insurance   100 

to  close  the  balance  of  Insurance  Account  into 
Expense. 

i 

If  this  method  be  followed,  the  unexpired  insurance  will  have  to 

be  brought  back  to  the  Insurance  Account  after  the  latter  is  closed 
and  ruled  so  the  process  can  be  repeated  in  the  next  period  just  as 
merchandise  Inventory  is  restored  to  the  Purchases  Account. 

On  the  other  hand,  we  may  choose  to  regard  Insurance  Account 
as  being  itself  in  the  nature  of  a  Deferred  Charge  Account — i.  e.,  the 
balance  shall  represent  the  amount  of  insurance  unexpired.  In  order 
to  keep  the  account  according  to  these  designated  characteristics,  it 
is  only  necessary  to  remove  the  amount  of  expired  insurance  at  the 
end  of  the  period  by  Journal  Entry.  The  sequence  here  is  as  fol- 
lows— 

(1) 

Insurance    $  1,200 

Cash $  1,200 

Insurance  premium  paid  for  year  in  advance. 

(2) 

general  Administrative  Expense. . . .' 100 

Insurance   100 

to  transfer  to  Expense  the  expired  portion  of 
Insurance. 

The  $1,100  balance  remaining  in  Insurance  Account  is  the 
amount  unexpired  and  carried  in  the  books  into  the  next  period. 

59 


As  far  as  Insurance  Account  is  concerned,  this  latter  is  the  sim- 
pler treatment,  but  it  should  not  be  followed  for  that  reason  if  it  is 
inconsistent  with  the  treatment  accorded  other  Deferred  Charges,  such 
as  supplies.  If  supplies  are  treated  first  as  expenses  (debited  to  Ex- 
pense), and  later  adjusted  by  the  removal  of  the  unused  portion,  the 
treatment  of  insurance  should  be  similar.  Either  that  or  supplies 
should  be  treated  like  insurance  in  the  second  illustration  above. 
Similar  accounts  should  receive  similar  treatment. 

Adjustments  are  made  for  Deferred  Charges  and  Deferred  In- 
come in  order  to  carry  over  prepaid  items  into  the  subsequent  period 
where  they  are  used.  There  are  adjustments  also  in  the  case  of  serv- 
ices, etc.,  used  in  the  current  period  but  paid  for  in  later  periods. 
These  are  discussed  next. 

Accrued  Liabilities.  Wages,  for  example,  and  Interest,  accumu- 
late day  by  day,  but  for  convenience  are  charged  to  Expense  when 
paid  rather  than  daily.  Wages  are  paid  usually  once  each  week; 
Interest  whenever  the  interest-bearing  note  is  paid.  Now  if  the  end 
of  the  month  falls  between  pay  days  or  between  payments  of  inter- 
est, a  certain  amount  of  wages  or  interest  will  have  accumulated  un- 
paid. These  accrued  wages,  etc.,  are  as  much  a  part  of  the  costs  of 
the  period  just  closed  as  if  they  were  paid  in  cash,  for  the  services 
of  the  employees  has  been  rendered  within  the  current  month.  It 
will  be  noted,  too,  that  since  the  work  has  been  done,  the  employees 
are  owed  the  wages  even  though  the  money  be  held  back  until  Sat- 
urday. To  the  business,  then,  there  is  a  direct  liability  not  yet  ex- 
pressed in  the  accounts. 

Before  closing  at  the  month  end,  an  adjustment  entry  is  to  be 
made  to  set  up  these  unrecorded  liabilities  and  to  bring  the  unrecorded 
costs  into  the  nominal  accounts  while  the  accounts  are  still  open.  The 
entry  for  accrued  wages  not  due  is  as  follows : 

Expense  (or  proper  sub-expense  account) $      200 

Accrued   Liabilities $      200- 

to  set  up  wages  accrued  but  not  due  for  the 
three  days,  Aug.  29,  30,  and  31. 

Any  other  liabilities  not  recorded  on  the  books  are  brought  in  at 
this  time  in  a  similar  entry  or  as  a  part  of  this  one. 

Accrued  Assets.  As  one  would  expect,  there  are  also  certain 
adjustments  to  be  made  for  accumulating  Assets  which  are  not  yet 
due.  Interest,  commission  earned  by  us,  etc.,  accrue  day  by  day,  but 

60 


like  wages,  are  not  brought  into  the  accounts  daily  because  of  the 
necessary  inconvenience  of  doing  so.  When  the  end  of  a  period  is 
reached,  however,  such  items  must  not  be  overlooked.  Take  commis- 
sions due  us,  for  example;  it  may  be  the  agreement  that  they  shall 
be  settled  for  only  once  in  three  months.  At  the  end  of  the  first 
month  there  is  an  amount  accrued  because  the  selling  service  has  been 
performed  but  the  payment  is  not  due  because  of  the  three-month 
agreement.  Our  accounts  can  not  express  the  whole  truth  of  the 
present  situation  unless  an  adjustment  be  made  to  increase  the  earn- 
ings of  this  month  by  the  amount  of  the  commissions  and  to  increase 
the  Assets  by  the  amount  to  be  paid  to  us  at  a  later  date.  The  entry 
would  be : 

Accrued    Assets $      400 

Commission  Earned $     400 

to  bring  into  the  current  period  the  earnings 
from  commissions  not  yet  due  or  collectible. 

Other  accrued  Assets  would  be  adjusted  through  this  or  a  similar 
entry. 

The  following  series  of  entries  will  show  the  sequence  of  adjust- 
ments for  one  type  of  transaction ;  but  it  may  be  used  as  a  guide  for 
other  types  of  adjustment  transaction  at  will.  It  will  be  well  in 
studying  this  series  of  entries  to  open  memorandum  accounts  and  post 
each  step  as  it  is  taken  so  the  slowly  effected  alteration  in  the  Ledger 
may  be  observed. 

(1)  July  12 

Selling  Expense , $  2,000 

Cash    .•;••••• $  2,000 

20,000  advertising  circulars  purchased. 

(2)  July  31 

Deferred  Charges 1,800 

Selling   Expense : 1,800 

18,000  circulars  unused  and  carried  over  to 
subsequent  periods. 

(3)  July  31 

Profit  and  Loss 200 

Selling   Expense 200 

to  close  the  remainder  of  Selling  Expense 
Account  to  the  current  Profit  and  Loss  Ac- 
count. 

Step  (i)  shows  the  acquisition  of  Expense  Material;  step  (2) 
the  removal  of  the  unused  portion;  step  (3)  the  removal  of  the  used 
portion;  since  the  unused  circulars  are  to  be  used  in  later  months  it 
is  not  unnatural  that  they  should  soon  be  restored  to  the  Expense  ac- 
count for  the  next  month.  That  is  step  (4)  of  the  sequence. 

61 


(4)  Aug.   1    (or  July  31) 

Selling   Expense $  1,800 

Deferred    Charges 

to    restore    the    unused   circulars    to    the   Ex- 
pense   Account    after    it    is    closed    for    July. 


1.800 


Entry  (4),  as  far  as  it  affects  Selling  Expense,  is  identical  with 
the  record  of  a  fresh  purchase  during  the  month  of  August.  Indeed, 
it  may  help  to  think  of  the  adjustment  as  showing  a  purchase  of 
circulars  by  one  period  from  the  preceding  one.  Again  it  may  help 
to  think  of  these  adjustments  as  a  special  form  of  Inventory  handed 
on  by  one  period  to  be  used  in  the  next. 

After  entry  (4)  the  series  would  begin  again  and  follow  the 
same  course.  A  typical  Selling  Expense  Account  would  be  like  the 
following : 

Selling  Expense 


July  12— Circulars   purchased   $2,000 


Aug.     1 — Unused  circ.  from 

July    1,800 

Aug.  14— Other   Selling  costs.  3,000 


$4,800 


July  31 — Unused  circ.  de- 
ferred    $1,800 

July  31 — Closing  used  circ. 

to  P/L  a/c..  200 


Aug.  31— Deferred  Selling 
Exp 

Aug.  31 — Close  Balance  to 
P/L  a/c.. 


3,300 


$4,800 


Etc. 


It  is  equally  easy  to  think  of  Deferred  Income  as  a  special  kind 
of  Inventory  of  Incomes  which  is  removed  temporarily  from  the  cur- 
rent period's  income  account,  carried  in  a  special  account  by  itself 
while  the  books  are  being  closed,  and.  then  restored  to  the  Income 
account  for  the  month  following.  It  may  help  to  think  of  Accrued 
Assets  in  the  light  of  a  special  kind  of  earning  or  sales  on  account 
later  to  be  received  in  cash;  it  may  help  to  conceive  Accrued  Liabili- 
ties as  a  kind  of  purchase  or  expense  on  account  later  to  be  paid  in 
cash.  But  the  principal  guide  of  making  adjustment  entries  is  this: 
Make  whatever  debits  and  credits  are  necessary  to  raise  or  lower 
costs,  earnings,  assets .  or  liabilities  to  the  true  amount  according 
to  the  best  information  at  hand. 


Reserves.    There  is  one  other  matter  to  be  considered  while  on 
the  subject  of  adjustments  to  secure  true  costs,  and  that  is  reserves. 

62 


We  know  that  with  constant  use  our  Fixed  Assets  of  Buildings,  Ma- 
chinery, etc.,  wear  out,  and  we  know,  too,  that  it  is  quite  likely  some 
of  our  Accounts  Receivable  will  never  be  collected  in  cash.  If  it  were 
merely  a  question  of  waiting  to  make  the  necessary  adjustment  until 
the  machine  was  worn  out,  or  until  John  Hamilton's  account 
proved  uncollectible,  the  explanation  would  be  short  and  easy.  We 
should  simply  eliminate  the  worthless  asset  by  decreasing  the  account 
and  charging  the  amount  against  profits. 

But  we  are  to  note  that  the  wear  and  tear  on  Buildings  and 
Machinery  from  their  being  used  goes  on  month  by  month;  that  they 
contribute  day  by  day  to  the  care  and  disposition  of  everything  we 
sell ;  that  the  wearing  out  of  machines  is  as  much  a  cost  as  a  rent  for 
them  would  be.  And  we  are  also  to  note  that  an  uncollectible  Ac- 
count Receivable  is  quite  as  much  a  loss  and  a  reduction  of  the  profits 
as  the  destruction  by  fire  of  the  original  goods  would  have  been. 

The  depreciation  of  Fixed  Assets  is  in  the  nature  of  a  Selling 
Expense  if  the  particular  asset  suffering  wear  and  tear  is  used  in 
promoting  sales;  if  the  asset  cannot  be  intimately  connected  with 
selling,  the  Depreciation  is  considered  as  a  General  Administrative 
Expense.  An  Uncollectible  debt  may  be  brought  into  a  new  account, 
Loss  on  Doubtful  Accounts,  and  through  it,  closed  into  Profit  and 
Loss  Account. 

Perhaps  the  natural  entry  to  express  Depreciation  would  be  this: 

General   Administrative  Expense $      100 

Machinery $      100 

to  take  out  of  Machinery  Account  the 
amount  representing  the  portion  of  the  value 
of  the  machine  consumed  in  wear  and  tear 
in  the  current  period. 

It  would  seem  logical  thus  to  decrease  the  balance  of  Machinery 
Account  month  by  month  as  it  wore  out.  But  business  men  prefer 
to  keep  the  original  cost  of  the  Fixed  Assets  unchanged  in  the  ac- 
counts as  a  matter  of  record.  This  means  that  depreciation  can  not 
well  be  credited  to  the  asset  direct.  What  we  do  in  this  situation, 
and  to  have  the  costs  correct,  is  to  provide  a  separate  account  which 
shall  take  the  place  of  the  credit  side  of  the  Asset.  The  credits  of 
the  adjusting  entry  for  depreciation  comes  to  this  Reserve  for  Depre- 
ciation Account  just  as  if  the  new  account  was  the  split-off  credit  side 
of  the  Asset  Account. 

In  the  Balance  Sheet  the  Reserve  (credit  balance)  is  deducted 
from  the  Asset  (debit  balance).  The  resulting  remainder  is  the  pres- 

63 


ent  value  of  the  machinery  as  clearly  as  if  the  Machinery  Acount 
itself  had  received  the  depreciation  credits. 

Perhaps  it  would  seem  logical  also  to  credit  Accounts  Receivable 
for  uncollectible  accounts.  But  let  it  be  noted  that  to  follow  this 
plan  we  would  have  to  wait  until  long  after  the  sale  of  the  goods. 
The  profits  of  that  later  period  should  not  bear  the  burden  for  the 
bad  debts  contracted  in  an  earlier  period  merely  because  the  debt  is 
just  now  ascertained  to  be  uncollectible. 

Actuated  by  the  desire  to  show  in  each  current  period  all  costs 
and  losses  reasonably  belonging  in  that  period,  we  deduct  from  cur- 
rent profits  an  amount  which  experience  tells  us  will  approximate 
the  actual  loss  from  bad  debts  later  to  be  experienced.  Instead  of 
crediting  the  Accounts  Receivable  Account  at  this  time,  the  amount 
is  carried  to  the  Reserve  for  Uncollectible  Accounts.  We  could  not 
credit  Accounts  Receivable,  for  no  one  can  tell  now  which  of  the  sev- 
eral customers'  accounts  will  ultimately  prove  uncollectible,  though 
we  may  be  fairly  certain  that  in  the  long  run  about,  say,  one  per 
cent  of  the  sales  will  be  lost  from  bad  debts. 

There  are,  then,  two  other  adjusting  entries  to  be  made  in  addi- 
tion to  the  ones  for  accrued  and  deferred  items  and  before  closing 
the  nominal  accounts.  The  two  others  are  these: 

General  Administrative  Expense $      140 

Selling    Expense 

Reserve  for  Depreciation 

to  charge   depreciation  on   Fixed   Assets   into 
the  current  period's   expense. 

Loss  on  Bad  Debts 200 

Reserve  for  Bad  Debts 

to  establish  a  reserve  of    percent  _of  the 

current    sales   to   cover    future   losses   in   col- 
lections. 

PROBLEMS— CHAPTER  IX. 

1.  Open  Ledger  accounts  for  such  exercises  as  the  teacher  may 
select  from  the  text  book;  make  proper  adjusting  Journal  entries  ac- 
cording to  the  information  at  hand;  post  the  adjusting  entries;  take  a 
Trial  Balance. 

2.  Make   closing   entries   and   statements    for   the   exercises    in 
problem  I  above. 


otomount 
Pamphlet 

Binder 
Gay  lord  Bros. 

Makers 
Syracuse,  N.  Y. 

PAT.  JAN  21,  1908 


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